401(k) Loan Outstanding when Participant Dies

[Guest progressivejoe]

I found several threads on these boards discussing the question of how to deal with outstanding 401(k) plan loans when the participant dies prior to full repayment, but none of them seem to come to a conclusion I'm comfortable with. The issue doesn't seem to be addressed at all in Treas. Reg. 1.72(p)-1 which deals with loans treated as distributions and I haven't found another good source of authority.

Here's the situation. Participant has $100,000 in his 401(k) plan. He takes out a loan for $10,000, the repayment of which he defaults on. Then he dies. The IRS has not yet taken any lien/levy type enforcement action. The plan says they will send a 1099 to the estate, but the estate is insolvent (there's not even enough to pay for administration expenses, so the IRS won't get anything out of the estate. I want to tell the non-spouse beneficiary that she can take the the remaining balance of the 401(k) plan without worrying about the IRS holding her liable for the participant's debt and penalties/interest on that debt.

Does anyone have any thoughts on where I can find authority for this question? Any insight would be a great help. Thanks!

[namealreadyinuse]

The plan, loan procedures, and loan note control, but by paying the "remaining balance" balance to the beneficiary, the loan is paid off, isn't it?

The answer is going to be that the loan is offset (paid off) against the account and beneficiary gets leftover.

[Guest mjb]

Joe: You need to have the beneficiary discuss the tax liability with a tax advisor because the IRS can recover taxes due from someone who inherits property of a decedent who owed taxes.

[Guest progressivejoe]

mjb, The Internal Revenue Manual (section 5.17.3.5.24.5) says that the IRS cannot levy on retirement plan assets after a participant's death because after the participant's death, the levy attaches to the rights of the participant's estate (and the plan assets generally never become property of the estate). The Manual goes on to say that "in order for the Service to collect what a taxpayer can receive from a plan while he is alive, it must have levied on the assets prior to his death." So, while the IRS can in some cases go after beneficiaries of a decedent's estate for debts of the decedent, I don't think they can go after the beneficiary of a 401(k) plan that never became part of the estate. The plan administrator is right to send the 1099 to the estate and normally the estate would pay the tax and penalty on the defaulted amount of the 401(k) loan and that would be the end of the story. The quirky part here is that the estate is insolvent so I'm trying to find some authority that the IRS cannot then go after the beneficiary of the 401(k) plan. I'm pretty confident that the 401(k) beneficiary is safe, but I'd be more comfortable if I could find something more authoritative than my confidence and the Internal Revenue Manual (which cannot be relied on by taxpayers).

[Guest progressivejoe]

namealreadyinuse, the plan and loan documents will dictate what the plan should do, but my question concerns the IRS enforcement options. Under the facts I suggested above, the 401(k) plan should send the beneficiary $90,000, and (for simplicity assume the participant never paid anything back on the $10,000 loan) send a 1099-R to the participant's estate for $10,000. The estate would then owe tax and penalty on that $10,000 (let's assume $3,000). The estate is insolvent and can't pay the IRS anything. So the question now becomes, can the IRS look to the beneficiary's $90,000 to get the participant's/estate's $3,000 liability on the 401(k) loan default?

[Bird]

progressivejoe-

You're probably the resident expert on this topic, based on the depth of your replies. Very interesting and thanks for the education.

I don't know for sure, but I'd guess, as it seems you are, that the fact that the tax debt arose from a qualified plan loan default does NOT necessarily taint the remaining plan account and subject the bene to an IRS levy.

[Earl]

so, just before you die, take out a maximum loan.

not all die old or quickly.