Defaulted 401K Plan Loan

[Christian]

A client is sending me her tax info which she says has information on a loan taken from her 401K plan for her soon to be divorced husband . He defaulted and I am wondering how this will be reported. I would think on a 1099-R issued to her indicating a code 1 distribution. Is this correct ? She is 40 yoa.

[grandmabee]

That is correct.

[Lion EA]

Remind her to tell her lawyer about this and that hubby defaulted. It's going to be income on her P&L for the divorce papers, instead of a liability to repay. That's going to make things lopsided if the proceeds were used by hubby for his biz or whatever. She needs to be able to explain this better or it's going to hurt her financially in the divorce. Maybe after reviewing her documentation, you can help her lay out the timeline for her lawyer. Well, after 15 April, if possible.

[jklcpa]

Yes, it is reported as you described.  1099-R, code 1, and subject to the penalty.

The plan documents will govern when the loan actually goes into default, and whether it is a deemed distribution (not eligible for rollover) or if there is a plan offset, in which case IS eligible for rollover.

Here's a Q&A from the IRS that may be helpful to you as a start: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans#5

[Pacun]

Let's keep it within our business. She has a 1099-R with code 1, which means that she has to pay Federal and State taxes in addition to the 10% penalty. That's all we need to know. How SHE defaulted to the loan is "Beyond the 1040".  The ex didn't default, most likely, SHE was the one that got fired and didn't have the money to repay the loan. Remember she was the ONLY one that could request the loan, she is the ONLY one whose pay check was going to be reduced and she is the only one the IRS will go after if she is filing MFS.  Most of the underlined is just my assumption but we don't need to dig because the 1099-R has better communication skills and its owner. 

 

[Randall]

1 hour ago, Pacun said:

Let's keep it within our business. She has a 1099-R with code 1, which means that she has to pay Federal and State taxes in addition to the 10% penalty. That's all we need to know. How SHE defaulted to the loan is "Beyond the 1040".  The ex didn't default, most likely, SHE was the one that got fired and didn't have the money to repay the loan. Remember she was the ONLY one that could request the loan, she is the ONLY one whose pay check was going to be reduced and she is the only one the IRS will go after if she is filing MFS.  Most of the underlined is just my assumption but we don't need to dig because the 1099-R has better communication skills and its owner. 

 

I agree Pacun.  Let the he said she said stay with the lawyers.

[Gail in Virginia]

I agree with Randall and Pacun as to our responsibility.  However, I don't think that it is a bad idea to just tell her that if this loan was really for the benefit of her husband and he is the one who defaulted on payments, she should discuss this with her lawyer in case it impacts the settlement in any way.  kick the ball to the attorney - that is why they get the big bucks.  But our clients don't always realize what is important and I would prefer to err by advising them to consult the professional. 

[Pacun]

Gail,

I agree with you but how do we know that  the "loan was really for the benefit of her husband and he is the one who defaulted on payments"? What we know is that the wife was the one that defaulted on the payments and that's why she got the 1099-R.

In any event, my clients ALWAYS ask me: "Conoce algun buen abogado que me pueda recomendar?" (do you know any good lawyer that you can recommend?). My answer is "Such an animal doesn't exist!!!!"

 

 

[jasdlm]

4 hours ago, Pacun said:

Gail,

I agree with you but how do we know that  the "loan was really for the benefit of her husband and he is the one who defaulted on payments"? What we know is that the wife was the one that defaulted on the payments and that's why she got the 1099-R.

In any event, my clients ALWAYS ask me: "Conoce algun buen abogado que me pueda recomendar?" (do you know any good lawyer that you can recommend?). My answer is "Such an animal doesn't exist!!!!"

 

 

I'm sure you forgot about me when you gave this answer!    There are a few of us around who are A-OK and working for the greater good.