Repay 401K loan with in 5 year term

[Andy Daniels]

A deemed distribution of unpaid loan balance in 2015 after leaving employment was recorded on tax return as income. If loan is then paid back three years later including all interest etc.. Can an amended tax return then be filed to remove the 1099R distribution?

[Bill Presson]

No. The repaid loan creates an after-tax basis in the plan when the distribution is ultimately made.

https://www.napa-net.org/news/technical-competence/case-of-the-week-repayment-of-defaulted-plan-loan-after-deemed-distribution/

 

[ESOP Guy]

Does this question even make sense? 

I see the timeline as follows:

Person terminates in 2015.  The loan is defaulted and is taxable for that year.

The loan was paid in full 3 years after you left employment.  That is the part I don't get. 

They let you pay a 401(k) loan after you terminated and it was made taxable to you?  

[Luke Bailey]

7 hours ago, ESOP Guy said:

Does this question even make sense? 

I see the timeline as follows:

Person terminates in 2015.  The loan is defaulted and is taxable for that year.

The loan was paid in full 3 years after you left employment.  That is the part I don't get. 

They let you pay a 401(k) loan after you terminated and it was made taxable to you?  

ESOP Guy, it makes sense if the loan was only deemed distributed (i.e., participant did not take a distribution of his/her account in connection with separation from service) and not offset.

[ESOP Guy]

13 hours ago, Luke Bailey said:

ESOP Guy, it makes sense if the loan was only deemed distributed (i.e., participant did not take a distribution of his/her account in connection with separation from service) and not offset.

I am not a 401(k) loan expert as I have been an ESOP and balance forward PSP/MPP person most of my career.   But I thought a deemed distributed loan was actually distributed automatically when a distributable event happened.  Are you saying there has to be a distributable event AND the person has to take a distribution of his other assets from the plan before the loan to leave the plan's books? 

[Luke Bailey]

10 hours ago, ESOP Guy said:

I am not a 401(k) loan expert as I have been an ESOP and balance forward PSP/MPP person most of my career.   But I thought a deemed distributed loan was actually distributed automatically when a distributable event happened.  Are you saying there has to be a distributable event AND the person has to take a distribution of his other assets from the plan before the loan to leave the plan's books? 

ESOP Guy, I think that to actually get rid of the dead loan you need more than just a separation from service. The individual has to either request a distribution of there has to be some rule that allows you to distribute without consent, e.g. under $5,000, 401(a)(9), etc. The following sentence is from Treas. reg. 1.72(p)-1, Q&A-13(a)(2):

"A distribution of a plan loan offset amount could occur in a variety of circumstances, such as where the terms governing the plan loan require that, in the event of the participant's request for a distribution, a loan be repaid immediately or treated as in default."

Obviously, there is an ordering issue, here, e.g. if the dead loan is $10,000 and the individual has a balance of $100,000 and requests a distribution of $20,000, can you say the first $10,000 is the dead loan? Probably, but you would have to have that in your plan or perhaps loan document, or have the flexibility under your plan document to apply that as a uniform rule.

Q&A-21 of the same reg actually deals with the issue of the participant's basis where he/she repays a previously deemed distributed loan. While the period in the example in Q&A-21 is much shorter than the three-year period in Andy Daniels' original question, I think the same principle would apply.

[Kevin C]

Plan language may also affect the timing of an offset.  Our VS document says:

Quote

Offset of defaulted loan. If a Participant defaults on a Participant loan, the Plan may not offset the Participant’s Account Balance until the Participant is otherwise entitled to an immediate distribution of the portion of the Account Balance which will be offset and such amount being offset is available as security on the loan, pursuant to Section 13.06. For this purpose, a loan default is treated as an immediate distribution event to the extent the law does not prohibit an actual distribution of the type of contributions which would be offset as a result of the loan default (determined without regard to the consent requirements under Sections 8.04 and 9.04, so long as spousal consent was properly obtained at the time of the loan, if required under Section 13.08).

 

[Luke Bailey]

Thanks, Kevin C. Figured that some plans would have language like that, though not required. From a design perspective, such a provision has pros and cons, I think.