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2. Substantially Level Amortization
In order for a loan to qualify for the section 72(p)(2)
exception to taxable distribution treatment, the loan must
provide for substantially level amortization over its term. See
sec. 72(p)(2)(C). The substantially level amortization
requirement under section 72(p)(2)(C) has been interpreted as
requiring that payment of principal and interest be made in
substantially level amounts over the term of the loan. See
Estate of Gray v. Commissioner, T.C. Memo. 1995-421. If we treat
the promissory note as requiring a balloon payment in the fifth
year, then the promissory note would call for 59 monthly payments
of $253.57 and a final balloon payment of $20,119.89. The
balloon payment is more than 79 times larger than the regular
monthly payment, and more than 80 percent of the initial
principal balance. From a textual standpoint, these payments
simply cannot be characterized as substantially level. From a
policy standpoint, one of the stated purposes behind the
enactment of section 72(p)(2)(C) was to prevent taxpayers from
currently enjoying plan assets through the use of balloon payment
loans:
The rules governing the tax treatment of loans
from certain tax-favored plans are intended to limit
the extent to which an employee may currently use
assets held by a plan for nonretirement purposes and to
ensure that loans are actually repaid within a
reasonable period. However, there is concern that the
present rules do not prevent an employee from
effectively maintaining a permanent outstanding $50,000
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