Distribution and Loan Offset Exceeds $100,000 limit

[Vlad401k]

Let's say a participant has $80,000 in their 401k. He also has a $40,000 loan. The participant is terminated due to COVID and would like to take a full distribution. He's under 59 1/2. Since the limit for COVID distribution is $100,000, how would you process this request? The participant chose to have no taxes withheld on the COVID distribution and my understanding is that Code "2" is used for COVID distributions if the participant is under 59 1/2.

 

So, I'm thinking we process the request as follows:

 

The loan Offset of $40,000 is processed under Code 2.

$60,000 of the distribution amount is processed under Code 2 (with no Federal Tax withholding)

The remaining $20,000 of the distribution amount is processed under Code 1 (with Federal Tax withholding) because the $100,000 limit has been reached.

 

Would you agree?

[C. B. Zeller]

I don't know that there has been any official word on the use of code 2 for coronavirus-related distributions, but it seems like a reasonable approach.

The loan offset is a qualified loan offset (code M) since it is due to termination of employment.

It probably benefits the participant the most if you do $80,000 from the account as code 2, $20,000 from the loan as code 2M, and $20,000 from the loan as code 1M. Then they have the opportunity to repay $20,000 of the loan offset to an IRA by their tax filing deadline for 2020 in order to avoid being taxed on it and avoid the penalty under 72(t).

[Bird]

What is the justification for Code 2?  I'd use 1 or 7 as appropriate.  I don't think it is our job to determine what is a CRD for tax purposes.  For distribution processing yes.  I know it seems like a fine line or no line at all but for me it is pretty bright.  I wouldn't even use Code 2 for disability unless I had some rock solid proof.

[Larry Starr]

3 hours ago, Vlad401k said:

Let's say a participant has $80,000 in their 401k. He also has a $40,000 loan. The participant is terminated due to COVID and would like to take a full distribution. He's under 59 1/2. Since the limit for COVID distribution is $100,000, how would you process this request? The participant chose to have no taxes withheld on the COVID distribution and my understanding is that Code "2" is used for COVID distributions if the participant is under 59 1/2.

 

So, I'm thinking we process the request as follows:

 

The loan Offset of $40,000 is processed under Code 2.

$60,000 of the distribution amount is processed under Code 2 (with no Federal Tax withholding)

The remaining $20,000 of the distribution amount is processed under Code 1 (with Federal Tax withholding) because the $100,000 limit has been reached.

 

Would you agree?

Just want to clarify how this should be thought of. He doesn't have $80,000 in his 401(k), he apparently has $120,000, which consists of various assets, including a loan receivable.  Just want folks to think of this from the accounting standpoint when they address these kinds of issues.  I think the other responses you got are fine and I expect we will get guidance before the 1099s are due next year, but I would tend to code 1 as well. The participant is going to have to justify on his personal return.