401 k loan

[gman]

Taxpayer took a loan from his 401K. He went online and set it up himself. He later told payroll and they began taking deductions. He has received a 1099 for the amount and subj to 10% penalty..... Taxpayer said deductions were taken from paychecks. Called fidelity(1099 payer) they said payments were made too late and loan defaulted....
Once the payments were started, they did not stop, were just sent in late from payroll....maybe taxpayer informed they too late and payments were made late... that being. if he continues to make payments and the loan is paid off..,could he avoid tax and penalty...Fidelity said payments were recieved late and loan was in default....but if the loan is completely paid back at some point can we avoid any tax ?????

[Koss]

Defaulted?

If the loan was declared to be in default, then...

the loan was converted to a distribution. That means he gets to keep the money. It's no longer a loan, and he doesn't have to pay it back.

That does indeed make it subject to regular tax and the 10% penalty, and it probably can't be avoided.

Here's the part I don't understand:

Why did Fidelity continue to accept payments after the loan was converted to a distribution?

And what are they doing with that money if he no longer has a loan outstanding??



Are they treating the payments as contributions?

BMK

[Roland Slugg]

Look into the grace period

Regs. §1.72(p)-1 (Q&A 10) says the following:

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.

It may be worthwhile to look into this.