Proper Tax Code to use for Loan Offset due to Disability

[Bruddah Kimo]

I have a participant in a 401k Profit Sharing Plan who went out on disabililty in March 2007. She had an outstanding loan at the time and has submitted paperwork to have her loan balance offset due to disability. She is age 47.

Two questions:

1) What is the proper tax code to use for the 2007 1099-R to be generated for the loan offset.

2) Is she subject to the 10% early withdrawal tax penalty for the loan offset.

I think she should receive a 1099-R coded as '3' and she would not be subject to the 10% penalty, but I would like to see if anyone agrees.

Mahalo!

[Appleby]

I agree, as the offset is really a true distribution...unlike a deemed distribution which is not ( a true distribution).

[John Feldt ERPA CPC QPA]

Use code 3 if you really truly know the participant meets the IRS definition for disability. Otherwise, do not.

If you do not, and the participant believes they are exempt from the penalty, they attach Form 5329 to their Form 1040 and add the code there to explain their exemption from the 10% penalty tax.