According to the Tax Exempt and Government Entities Division of the Internal Revenue Service (IRS), one out of every four (25%) of 401(k) plans surveyed in a recent study had engaged in prohibited transactions as a result of non-compliant participant plan loans and/or real estate investments that were not valued properly. http://www.irs.gov/pub/irs-tege/epn_2012_1.pdf
The problems noted by the IRS with respect to participant loans included:
1. not following the plan loan provisions,
2. not having a bona fide loan (no loan document and/or payments),
3. not having a provision for loans in the plan document, but allowing
participant loans, and
4. not prohibiting loans to the employer and/or related entities.
Plan loan violations can result in immediate taxation to the participant, excise tax penalties and possible plan disqualification. Failure to properly value non-publicly traded assets can lead to top heavy violations, prohibited transactions and distribution reporting errors. Retirement plans that permit participant loans should have a written loan policy and formal loan documents.