Loan default due to death of participant - who is liable for the taxes

[Guest John Grace]

A participant dies with an outstanding loan balance. The beneficiary requests payment of the remaining account balance, the plan defaults the loan, thereby creating a deemed distribution. With respect to the taxes that are now due on the deemed distribution, who is liable for the taxes on the defaulted loan? The participant (his estate) or the beneficiary?

[QDROphile]

You don't have a deemed distribution. You have an offset distribution to the beneficiary, who is responsible for the taxes on the distribution, which includes the amount of the loan.

[Michael Devault]

The offset distribution occurs because of the event which allows an actual distribution (in this instance, death of the participant).

[Guest John Grace]

QDROphile, I am not sure that I understand your response. Let me provide some additional info that I have gathered. A review of the plan document shows that "death" is an event that causes the loan to go into default. The loan is not offset against the participant's remaining account balance, but rather the outstanding balance becomes a deemed distribution and a 1099 is generated. The remainder of the account balance has not yet been transferred to the beneficiary. That being the case, is the beneficiary still responsible for the taxes? If so, do you know the code section that I can refer to?

[QDROphile]

The authority is under . A plan provision that death is a default event is unusual. The plan may have other unusual provisions, so take this response subject to plan provisions to the contrary. I would expect death also causes the participant's account to be distributable (to the beneficiary). Because the account is distributable, the loan is offset and treated as an offset distribution. See Q&A-13 of the proposed regulations and compare (a) and (B). Because distributions are taxed to recipient, the beneficiary gets the offset distribution and is responsible for the taxes on the distribution.

Could you get a different result by treating the offset distribution as a distribution to the participant, and therefore the participant is charged with the income for income tax purposes? Maybe. But one would expect all distributions after a participant's death to be made to the beneficiary. What does the plan say about that?

[This message has been edited by Dave Baker (edited 12-07-1999).]

[Guest John Grace]

QDROphile,

Thanks for pointing me to 1.72, I now understand that the situation I have results in an offset distribution and not a deemed distribution. You were correct in assuming that the participant's death creates a distributable event, causing the account to be distributed to the beneficiary.