By Jonathan A. Kenter, Evelyn Small Traub, Jeffery R. Banish, Lynda M. Crouse, Tina A. DeNapoli, Jeanne E. Floyd, Stephen G. Gorell, Kristina Rae Jones, Edith "Edie" Margaret Lindsay, Roger S. Reigner Jr., Mamta K. Shah and Wallace "Wally" M. Starke
During a recent phone forum, an IRS agent stated that the agency
views an interest rate equal to prime plus 2 percent as a "reasonable"
interest rate - effectively establishing a safe harbor rate. This
advisory reviews this guidance and what action plan administrators may
want to consider.
Generally, absent an exemption, a loan between a plan and a 401(k)
plan participant is a prohibited transaction under ERISA. Among the
requirements to escape prohibited transaction status, a participant loan
Under applicable Department of Labor Regulations, to be reasonable,
an interest rate must be consistent with interest rates charged by
commercial lenders for a loan made under similar circumstances. The
regulations do not provide a safe harbor rate.
Just as important as what the IRS agent said about a "reasonable"
interest rate is what the agent did not say: Whether an interest rate of
less than prime plus 2 percent would be considered presumptively
reasonable. Presumably, the answer would depend on the credit
worthiness of each borrowing participant. On that theory, there are
undoubtedly participants whose credit worthiness is such that a bank
would not issue them a loan at even prime plus 2 percent.
Nevertheless, although the comments of an IRS agent during an
IRS-sponsored phone forum are admittedly not official guidance, to
minimize their fiduciary liability, plan administrators issuing
participant loans at interest rates of less than prime plus 2 percent
may wish to rethink issuing loans at this rate and replacing it with
prime plus 2.
IRS Circular 230 Disclosure: To ensure compliance with
requirements imposed by the IRS, we inform you that any tax advice that
may be contained in this communication (including any attachments) is
not intended or written to be used, and cannot be used, for the purpose
of (i) avoiding any penalties under the Internal Revenue Code or (ii)
promoting, marketing or recommending to another party any transaction(s)
or tax-related matter(s) that may be addressed herein.
©Troutman Sanders LLP
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