401K in 08 never paid when due in 09

[AZ-Tax]

If I understood the TP correctly, the TP first had a 401K and took a loan from it. Then rolled over the 401K into an IRA with still a loan balance. Never paid off the loan that was taken in 2008 therefore Custodian issued TP 1099R for 2009 code 1 yet IRS letter states it was reported to them (the IRS) for 2008..

[S T]

1099R Form

Do you have a copy of the 1099R form that was issued?
It would provide you with either 2008 or 2009 tax years to be reported in the appropriate tax year.
IRS would be looking for the "loan balance as taxable income " not paid off in the year that the 401K account was closed out or rolled over, I would presume.

I am thinking you might need some more documentation

Sandy

[Kram BergGold]

Here is how it makes sense

The deemed distribution occurs when the taxpayer is in default. I would assume that your client missed paying not in 2008 but in 2009 that is why the 2009 1099R. Employers can give up to a 3 month grace period. So if he missed a payment in Oct 2008 this trigger could be delayed till January 2009.

[AZ-Tax]

NO 1099R w/code 1 received for tax yr 2008

according to the TP. The TP has yet to file 2008 tax return and the IRS mailed the TP a 2008 "tax calculation summary letter" listing $11124 as "IRA income subject to penalty" then list the penalty. The two 1099R's w/code 1 for tax yr 2009 recieved by the TP has box 1 amts of: $11516 & $10371 so neither amt matches the amt on the IRS letter for tax yr 2008.

Now what is even stranger about this is the TP started with a $18000 rollover balance in TP's IRA which was rolled over in early 2008. If the TP did recieve and misplaced a 1099R w/code 1 for 2008, all 3 1099R w/code 1 would add up to be more then $32000 and the stock market was not that rewarding in 08 & 09.. So what gives?

[FEDUKE404]

Possibility

If it was not an institution to institution rollover, TP may have rolled over only the net proceeds (after withholding taxes) and not the full amount of the account withdrawal.

Agree that tax event would occur when funds were "used" via non-repayment of loan.

Be sure to check for alpha code on the Forms 1099!

FE

[New York Enrolled Agent]

The deemed distribution occurs when the taxpayer is in default. I would assume that your client missed paying not in 2008 but in 2009 that is why the 2009 1099R. Employers can give up to a 3 month grace period. So if he missed a payment in Oct 2008 this trigger could be delayed till January 2009.

I think Kram is on target. See the example at the end.

Income Tax Regulation §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.

[snowshine]

I suggest getting an IRS income Transcript for both 2008 and 2009. If the loan, "carried over" to 2009 before the IRA conversion but the TP missed some 2008 payments the principal of the loan plus most of the interest would be the 2008 amount and then you would have a small 2009 1099-R for the final interest due plus any penalties/closing costs/transfer fees. Say, $392...

[Burke]

Most of these deemed distributiions occur when the TP terminates employment and the funds are then distributed. Is this what happened? The default occurs when the funds are paid out with an outstanding loan balance in effect. However, the employer is required to notify the TP of this impending event and the tax consequences, offering an option to repay loan in full before the payout occurs. I think you need to investigate a little further with the TP and his/her employer to determine what actually happened and when. The employer has this information.