In August 2003, a participant borrowed $1,300 from their employee deferral source. Upon receipt of a new loan application, we discovered no payments were made on the August loan. Obviously, she defaulted on the August loan. How do we treat this? And is she eligible for a loan currently assuming all other issues such as 50% of the vested account balance .... are OK?

See Q 19 in the 72(p) regs

Check your loan policy to determine is she is allowed another loan. The first loan should be deemed a distribution. The 1099-R would be issued for the year in which the loan is actually deemed. A deemed loan is treated as an outstanding loan for all loan limit purposes, so if the loan policy only allows one loan, she is not able to take an additional loan. Also, your loan policy may specifically state that if a participant has a loan in a deemed status, they are unable to take another loan.

The subsequent loan would also be treated as a taxable distribution unless the participant agrees to payroll withholding or gives additional security. See Q 19.