What happens to unpaid loan previously taxed as deemed distribution?

[Spencer]

I have a participant who took a pre-TEFRA loan for $300,000 amortized over 30 years to purchase a house. In 1996, he stopped making payments. The loan was deemed a distribution, included in his taxable income and a 1099R was issued.

The loan plus accrued interest was then re-amortized and he began making payments again. Now he has retired.

Does the loan just disappear when he takes a distribution since he's already been taxed on it?

[david rigby]

How can the "loan plus accrued interest" be re-amortized? If you deemed it a distribution and issued a 1099R, doesn't that mean that it is no longer in his account?

[bzorc]

My belief is that it does not show up again in taxes because he had already been taxed on the defaulted loan, back in 1996, from the fact situation. My only arguement would be that the accrued interest that was rolled up into the reamortized loan should be taxable.

I have actually seen where a defaulted loan was repaid after the 1099-R was issued. The key concept here, in my mind, is what the employment status of the participant is. It sounds like in Spencer's situation the participant remained employed. Pax mentions the account balance being written off the records for the participant. That would require, for most plans, that the person be terminated, which is an approved way of "distributing" the loan balance. When I would write a loan off for a terminated participant, I would accrue interest to the date of default, add it to the loan, and then distribute it.

The distribution of loans is always a sticky subject. I do know that there have been some IRS notices dealing with the accrual of interest on loans. As always, its clear as mud as to what to do.

Hope this helps.

[KJohnson]

In response to Pax's question, a loan has to "stay in" a participant's account after a deemed distribution until there is an event which can result in a loan offset.

Prop. Reg. 1.72(p)-1 Q&A 20 specifically provides that the tax basis (or investment in contract) is increased by any repayment of a loan after a a deemed distribution.

[Fredman]

Was the loan defaulted or offset? It sounds like it was only defaulted, otherwise (like pax sez) I can't see how he could begin making payments again.

Also, keep in mind that since the participant was repaying a taxed loan, those repayments should be considered "basis" when figuring the taxable portion of his account. Basis amounts are not eligible for rollover, should be distributed directly to the participant and reported as such (not taxable).

I hate loans...they shouldn't be allowed.