Loan as a Deemed Distribution

[CLE401kGuy]

Participant in a plan terminated in July of '12 and rehired December of '12. He had a loan. He did not timely repay outstanding loan payments so he was defaulted and had a deemed distribution for 2012.

In 2013, is there any way for the participant to pay back this loan and 'reverse' the 1099 for '12 in '13. Final-Reg, Tax-Regs 1.72(p) - Loans treated as distributions indicates is repayment continue after deemed distribution, tax basis in the plan increases - how does that affect the 1099 that was issued?

Any suggestions would be helpful... Thanks

[QDROphile]

No change to 1099. The balance of the loan is included in income. You have to determine if the loan was distributed because of the termination of employment --sometimes called an offset distribution. You said it was a deemed distribution but people are sloppy with words and the nuances are important. If the loan was distributed, it cannot be repaid. There is no plan loan. If the loan was not distributed, then the loan remains in the plan, continues to accrue interest, and can be repaid. Payments up to the amount that was included in income increase basis (will not be taxable again, or you may call the amounts "after tax").

[CLE401kGuy]

Ahh, so if it was a deemed distribution, the participant receives a 1099 for the portion that was deemed, but still continues to make payments which must be directed to a separate 'after tax' source set up to receive payments on the deemed distribution..... However, if due to the participant's terminated status that led to him missing the payments in the first place, it was considered a loan default and processed as an offset distribution - the loan is considered off the books altogether and it's basically a 'done deal.' - It gets tricky because the participant rehired several weeks before the loan was officially considered in default and the provider accepted a payment on the loan... In this situation, it may be best if the loan was considered in default and processed as an offset distribution so it's written off the books altogether - I appreciate the response...

[Kevin C]

The only way the tax treatment of a deemed loan can be changed is if the Employer files under VCP and specifically asks for the change in the tax treatment in connection with the loan correction. Rev. Proc. 2013-12 Section 6.07 (1) & (2). The loan must still be within the original maximum repayment period to be eligible.

[Guest TaxedToDeath]

Ahh, so if it was a deemed distribution, the participant receives a 1099 for the portion that was deemed, but still continues to make payments which must be directed to a separate 'after tax' source set up to receive payments on the deemed distribution..... However, if due to the participant's terminated status that led to him missing the payments in the first place, it was considered a loan default and processed as an offset distribution - the loan is considered off the books altogether and it's basically a 'done deal.' - It gets tricky because the participant rehired several weeks before the loan was officially considered in default and the provider accepted a payment on the loan... In this situation, it may be best if the loan was considered in default and processed as an offset distribution so it's written off the books altogether - I appreciate the response...

You indicated the participant was rehired before the defaulted loan was processed as an offset distribution. If this is the case, and the participant was not eligible for an inservice distribution at the time of the offset distribution, then the defaulted loan must have been processed as a deemed distribution and not an offset distribution, because the participant's rehire would mean he was no longer eligible for distribution. In that case, it is NOT best, as you state, to consider the loan in default and processed as an offset distribution, because this would be improper. (Similar errors occur when participants terminate employment, request distribution from a plan, then are rehired before the distribution is processed. Upon rehire, they are no longer eligible for distribution, so this negates their distribution request.) Based on your comments, it appear the defaulted loan must be processed as a deemed distribution and remain on the plan's books, with any payments the participant makes on the defaulted loan being accounted for on an after-tax basis.

[chuTzPA]

Employee goes off payroll due to lack of available work and does not receive income from September 2013 through end of year. Employee not terminated though. Loan payments are not made so loan is deemed distributed at 12/31/13. Since this is done in 2014, is this treated in 2013 taxes or 2014 taxes? I'm not a 1099 expert, but if its 2013 what is the late penalty?

[Bird]

Loan payments are not made so loan is deemed distributed at 12/31/13. Since this is done in 2014

That's contradictory. I think you mean the last day of the cure period was 12/31/13, so it defaulted in 2014. If so, the 1099-R would be for 2014.