Deemed Distributions – Participant Loans


Participant loans are available in many retirement plans, although plans are not required to offer participant loans. Failures may occur when participant loans exceed the maximum dollar amount, have payment schedules that do not meet the time or payment requirements, or go into default when payments are not made. Each of these failures, and other issues, will cause the loan (or a portion of the loan) to become a deemed distribution for tax purposes. This Issue Snapshot will summarize what triggers a deemed distribution and when it can occur. See Treas. Reg. Section 1.72(p)-1.

IRC Sections and Treasury Regulations

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)


A qualified retirement plan may, but is not required to, provide for participant loans. Loans are not permitted from IRAs or from IRA-based plans such as SEPs, SARSEPs and SIMPLE IRA plans. Participant loans are only permitted from qualified plans that satisfy the requirements of IRC Section 401(a), from annuity plans that satisfy the requirements of IRC Sections 403(a) or 403(b), and from governmental plans (defined in IRC Section 72(p)(4)(B)). See IRC Section 72(p)(4) and Treas. Reg. Section 1.72(p)-1, Q&A-2.

Causes of deemed distributions

When a participant loan fails the requirements of IRC Section 72(p), a deemed distribution may result. See Treas. Reg. Section 1.72(p)-1 Q&A-3. The following sets forth the events that cause a participant loan to fail IRC Section 72(p):

Enforceable agreement requirement

A participant loan must be a legally enforceable agreement (which may include more than one document) and the terms of the agreement must demonstrate compliance with the requirements of IRC Section 72(p)(2) and Treas. Reg. Section 1.72(p)-1. Thus, the agreement must specify the amount and date of the loan and the repayment schedule. The agreement does not have to be signed if the agreement is enforceable under applicable law without being signed. However, the agreement must be set forth in a written paper document or in a document that is delivered through an electronic medium under an electronic system as specified under Treas. Reg. Section 1.401(a)-21. See Treas. Reg. Section 1.72(p)-1 Q&A-3(b).

Maximum loan amount limit

IRC Section 72(p)(2)(A) provides that the amount of a participant loan, when added to the outstanding balance of all other loans to the participant from all plans of the employer, may not exceed the lesser of:

 i. $50,000, reduced by the excess (if any) of—
 I. the highest outstanding balance of loans from the plan during the one-year period ending on the day before the date on which such loan was made, over
II. the outstanding balance of loans from the plan on the date on which such loan was made, or
ii. The greater of (I) 50% of the participant's vested accrued benefit, or (II) $10,000.

Repayment period

IRC Section 72(p)(2)(B) states that the repayment period of the plan loan must be limited to five years, unless the loan is to purchase a dwelling unit which will, within a reasonable amount of time, be used as the principal residence of the participant. There is no requirement that the loan be secured by this principal residence. See Treas. Reg. Section 1.72-1, Q&A-5&6.

Level payment amounts and quarterly payments

IRC Section 72(p)(2)(C) requires substantially level amortization over the term of the loan, with payments not less frequently than quarterly. This requirement does not apply if a participant is on a bona fide leave of absence for a year or less. However, the loan (including interest that accrues during the leave of absence) must be repaid by the latest permissible term of the loan and the amount of the installments due after the leave ends must not be less than the amount required under the terms of the original loan. In other words, the five-year repayment term is not extended for a leave of absence. The payment amount must be adjusted to ensure the loan is still paid-off in five years. See Treas. Reg. Section 1.72(p)-1, Q&A-9.

There is a repayment exception for those in active military service under IRC Section 414(u). The plan may suspend the obligation to repay a loan during the period of active military service without causing the loan to be in default if the payments resume upon completion of the active military service. When the obligation to repay a loan is based on a period of active military service, the five-year repayment period can be extended. Treas. Reg. Section 1.72-1, Q&A-9

Timing of a deemed distribution

A deemed distribution occurs the first time that any of the requirements above are not satisfied in form or operation. This may occur at the time the loan is made or at a later date. See Treas. Reg. Section 1.72(p)-1 Q&A-4.

Deemed distribution on the date the participant loan is made

In three situations, the entire loan is considered a deemed distribution on the date the loan is made:

  • The loan terms violate the repayment term requirement of IRC Section 72(p)(2)(B),
  • The loan terms violate the level amortization requirement of IRC Section 72(p)(2)(C), or
  • There is no legally enforceable agreement as defined in Treas. Reg. Section 1.72(p)-1 Q&A-3(b).

Deemed distribution at date of failure

In two situations, a deemed distribution of an amount different than the original amount of the loan can occur:

  • If the amount loaned exceeds the limitations of IRC Section 72(p)(2)(A), then the deemed distribution is the amount by which the loan exceeds the limitations.
  • If the participant failed to make any installment payment when due in accordance with the terms of the loan, then the deemed distribution is the amount of the outstanding balance of the loan, plus accrued interest.

Cure period

When a participant fails to make an installment payment when due, the plan may provide for a "cure period" that cannot extend beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due. Treas. Reg. Section 1.72(p)-1 Q&A-4 and Q&A-10.


The Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136), also known as the CARES Act, provides that plans may implement certain special rules for qualified individuals relating to plan loan aggregate limits and repayment terms. A qualified individual is anyone who is diagnosed, or whose spouse or dependent is diagnosed with COVID-19 or is experiencing adverse financial consequences as a result of the COVID-19 pandemic. The definition of a qualified individual can be found in Notice 2020-50, Section 1.

Allowable loan amount

Section 2202(b)(1) of the CARES Act changes the dollar limit on loans made to a qualified individual on or after March 27, 2020 and before September 23, 2020. For these loans, the limits increase under IRC Section 72(p)(2)(A) as follows:

  • The $50,000 aggregate limit increases to $100,000 and
  • The aggregate amount of loans limit increases from 50% of the participant's vested accrued benefit to 100%.

Extension of payment terms

The due date of any loan repayment for a qualified individual that occurs between March 27, 2020 and December 31, 2020 is delayed for one year by Section 2202(b)(2) of the Cares Act. Any subsequent repayments of the loan must be adjusted to reflect the delay and any interest accruing during the delay. The period of delay must be disregarded in determining the 5-year period and the term of the loan under IRC Sections 72(p)(2)((B) and C).

If the plan elects to apply the provisions of the Cares Act, the plan document must be updated. The amendment must be adopted on or before:

  • The last day of the first plan beginning on or after January 1, 2022, or
  • Such later date as may be prescribed by the Secretary of the Treasury.

Issue Indicators or Audit Tips

  1. Review the plan document and/or loan policy to ensure that the plan is operating consistent with IRC Section 72(p).
  2. Examine the outstanding participant loan documents. Records containing the necessary information may include, but are not limited to, loan agreements, promissory notes, spousal consents, and residential purchase documents.
  3. Determine if a loan should be considered a deemed distribution. Factors to consider are failure to comply with the maximum amount, level amortization, or the enforceable agreement requirements of Treas. Reg. Section 1.72(p)-1.
  4. Examine any Form 1099-Rs for deemed distributions to ensure that they were issued for the tax year the participant failed to cure the defect by the expiration of the cure period that resulted in the deemed distribution.
  5. Look for indicators of fraud.