401K loan default

[WhiteOleander]

T/P was working at a company that had a 401K. He borrowed from it in 1998. Later that same year, he left employment at the company.

He knew that loan would become taxable as a distribution that year, but he did not receive a 1099 on it and forgot about.

In the meantime, he says someone bought out the company with the 401K program in 2001.

They have now issued a 1099 on the loan default for 2006. The company has gone defunct and the admistrators refuse to change the 1099. They say it stands.

T/P contends he should not have to include it into '06 income. It belongs to '98 income and that is a closed year.

Anyone have any ideas on how to approach the IRS about this?

[DaveO]

Be prepared for a long, hard fight.

The fact that he didn't report it when it was due will weigh heavily against him. If you were to amend 98 and report it they would be happy to access the penalty and interest. Unless the service asserts fraud they can't access him now.

Does he have all the loan documentation to show the dates when the loan was taken and when it defaulted? If so, you might attach a statment to his return explaining why the 1099 isn't included. If you get a sympathetic appeals officer you might win.

I had a T/P who withdrew funds from a pre-tefra annuity. Under the terms of his annuity he could withdraw principal at any time without penalty or tax. The company reported his distribution as taxable. We reported it consistent with his records. He had perfect records. Copies of the policy, checks, endorsements, name changes, everything. It still took nearly a year to win on appeals. We even filed a complaint with the department of insurance against the company that issued the 1099R. A year after we received the closing letter the insurance company finally issued a corrected 1099R showing the distribution as partially taxable, which was still incorrect, and worse they issued it for the wrong year.

More IRS notices, threats and appeals later we finally got out the second closing letter.

Maybe the question is, how much tax is it and how much is he willing to spend for you to represent him?

[New York Enrolled Agent]

Anyone have any ideas on how to approach the IRS about this?

Try showing them Reg. §1.72(p)-1, Q&A 10

Q-10. If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?

A-10. (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution AT THE TIME of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.

(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of this section when made, but there is a failure to pay the installment payments required under the terms of the loan (taking into account any cure period allowed under paragraph (a) of this Q&A-10), then the amount of the deemed distribution equals the entire outstanding balance of the loan (including accrued interest) at the time of such failure.

(c) Example. The following example illustrates the rules in paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions described in the introductory text of this section:

Example. (i) On August 1, 2002, a participant has a nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to be repaid over 5 years in level monthly installments due at the end of each month. After making all monthly payments due through July 31, 2003, the participant fails to make the payment due on August 31, 2003 or any other monthly payments due thereafter. The plan administrator allows a three-month cure period.

(ii) As a result of the failure to satisfy the requirement that the loan be repaid in level installments pursuant to section 72(p)(2)(C), the participant has a deemed distribution on November 30, 2003, which is the last day of the three-month cure period for the August 31, 2003 installment. The amount of the deemed distribution is $17,157, which is the outstanding balance on the loan at November 30, 2003. Alternatively, if the plan administrator had allowed a cure period through the end of the next calendar quarter, there would be a deemed distribution on December 31, 2003 equal to $17,282, which is the outstanding balance of the loan at December 31, 2003.

[ChEAr$]

and the kicker

is the 10% penalty for early withdrawal!

[WhiteOleander]

Thanks NYEA

Thanks for the code cite.

The amount distributed is 2900.00. He says it is the principle of the thing. He does not want to pay because it was owned on a prior year which is closed. If he had found something that would produce a refund on the closed year, he wouldn't get the refund. So, he doesn't want to pay them for this.

[JohnH]

Tell him your charge to handle it will be $3,000, payable in advance.
Maybe that will help him make a smart decision.

[WhiteOleander]

Tell him your charge to handle it will be $3,000, payable in advance.
Maybe that will help him make a smart decision.

I wish.

And of course, he wants to resolve this just as we are under the crunch for extensions.

[JohnH]

I admire people who want to do the right thing just for the "principle of it".
I just thought this might help him decide whether his principles have a price.