DB Loan Taxation

[mctoe]

Participant borrows $30,000 of after-tax contributions only from DB plan. A month later, the participant elects to cancel the loan. Is this a deemed distribution? If yes, what are the tax consequences to the participant?

[Lou S.]

I'm not sure I follow your question.

Are they defaulting on a participant loan?

What does the loan program say?

How do you borrow "only after tax money"?

[mctoe]

Yes, participant is defaulting on loan. Governmental plan doc permits after-tax loans to its active participants.

[mbozek]

See reg. 1.72(p)-1 questions 11 to 19 for answers.

[mctoe]

It appears that Q&A 11 would apply:

Q-11: Does section 72 apply to a deemed distribution as if it were an actual distribution?

A-11: (a) Tax basis. If the employee's account includes after-tax contributions or other investment in the contract under section 72(e), section 72 applies to a deemed distribution as if it were an actual distribution, with the result that all or a portion of the deemed distribution may not be taxable.

It also appears from this Q&A that the participant would not have a tax liability due to the fact that the loan only included after-tax money. Would a 1099R need to be issued in this example?

[mbozek]

I would file a 1099R for reporting purposes even if no taxable income is reported.

[mctoe]

Thank you mbozek. I had another thought regarding this; would IRC 72(e)(8) apply to this distribution upon issuance of 1099r? Thereby creating a distribution of both pre and post tax.

[ETA Consulting LLC]

Correct. They "ONLY" way you'd have a 'deemed' distribution is in the absence of a distributable event. This say nothing about taxation. So, when the loan fails to meet the requirements of 72(p), then it will become an actual distribution (e.g. no need to deem it until a distributable event because the participant is already eligible for a distribution.)

Now that you've established that an actual distribution is taken, you must now determine taxation. This is where you look at the entire account (be sure to account for pre 87 and post-86 basis), to determine which part of a distribution of after-tax basis and which part is considered earnings.

Good Luck!

[mctoe]

Thank you ETA Consulting.