LOANS - DEFAULT

[Guest SPrince]

When a participant defaults on a plan loan, the balance due on the loan is "deemed distributed" such that the balance due constitutes a taxable distribution. Ordinarily, taxable distributions from a plan are subject to 20% backup withholding. However, since the deemed distribution is not an actual distribution of cash, no backup withholding is ordinarily possible with respect to same.

In cases where the deemed distribution is made concurrently with a taxable distribution directly to the participant, we believe the 20% withholding obligation relative to the total of the deemed distribution and cash distribution must be satisfied, to the extent possible, from the cash portion of the distribution. However, what is a plan sponsor's obligation where the deemed distribution occurs at the same time as a (normally) non-taxable rollover to another qualified plan? May/must the employer withhold up to 20% of the deemed distribution from the rollover amount?

Thanks for the help in advance!

[Sully]

I’ll assume it is a loan offset and not a deemed distribution.

If the participant elects a taxable distribution then the withholding is calculated on the entire taxable amount, including the loan offset.

If the participant elects a rollover of the non-loan portion of the distribution then there is no withholding.