Deemed Distribution to Participant who has filed under Chapter 13

[Guest Suanne]

A participant has discontinued making payments on a plan loan. They have filed Chapter 13 bankruptcy. The participant's attorney has indicated that it is against the law to give the participant a 1099 for a deemed distribution of the loan due to failure to make timely payments, due to the participants being under Chapter 13 bankruptcy. Has anyone heard of this before? Do you have any sites referring to this?

[Harwood]

I have heard of bankruptcy lawyers taking this position.

They are wrong - the Internal Revenue Code must be followed on reporting defaulted loans. A Bankruptcy court can stop the payroll deductions for loan payments but they can't stop the tax consequences.

The Participant now has a new creditor - the IRS.

[mbozek]

See Reg 1.72(p)-1 Q 4 and 10. default after cure period results in income taxation of outstanding balance. Tell the lawyer that the participant can avoid default by continuing the loan payments. You could also tell the lawyer that the bankruptcy ct has no jurisdicton over the taxation of any amount in an individual's account.