Client defaults on 401k loan

[Janitor Bob]

I think I know the answer to this is "no", but wanted to make sure I was not missing something.....Client took a loan from their 401k last year ($18,000). later last year, they lost their job and could not afford to make the loan payments.....1099-R with $18,000.00 taxable (code 1L).

Is there any exception that could be used on the 5329 to avoid the additional 10%? None of the listed exceptions seemed to apply....No exceptions for hardship...i.e. job loss?

[Bob Hoffman]

Unfortunately, if it didn't get paid back before he/she severed employment, it is income.

[jainen]

>>Is there any exception that could be used on the 5329 to avoid the additional 10%?<<

There isn't much to work with. The additional 10% is considered a tax, not a penalty that can be abated for reasonable cause. Basically there are only the exceptions listed on Form 5329 such as the 60-day rollover.

But there is a provision to waive the tax in the related matter of failure to take an RMD, considering a reasonable error and steps to correct it. That just takes an explanation attached to the 5329, but you can also use a PLR to ask for an extension of the 60 day limit, typically for a third-party error.

Hope is totally dependent on the Commissioner's grace; so make it a real tear-jerker. Focus on the elements that were beyond the taxpayer's control, and the specific actions being taken to correct the problem and prevent its recurrence. Bank errors are pretty strong, as are presidentially declared disasters. (That's when the president tells us something else is bad, not when the president himself is a disaster.)

[TAXBILLY]

(That's when the president tells us something else is bad, not when the president himself is a disaster.)

Very good j !

taxbilly

[Janitor Bob]

>>Is there any exception that could be used on the 5329 to avoid the additional 10%?<<

There isn't much to work with. The additional 10% is considered a tax, not a penalty that can be abated for reasonable cause. Basically there are only the exceptions listed on Form 5329 such as the 60-day rollover.

But there is a provision to waive the tax in the related matter of failure to take an RMD, considering a reasonable error and steps to correct it. That just takes an explanation attached to the 5329, but you can also use a PLR to ask for an extension of the 60 day limit, typically for a third-party error.

Hope is totally dependent on the Commissioner's grace; so make it a real tear-jerker. Focus on the elements that were beyond the taxpayer's control, and the specific actions being taken to correct the problem and prevent its recurrence. Bank errors are pretty strong, as are presidentially declared disasters. (That's when the president tells us something else is bad, not when the president himself is a disaster.)

Thanks Jainen....This confirms my initial assesment. Not much I can do to defend her....She took the loan and used the proceeds for various things (pay bills, etc)....then decided to default without concern for the tax consequences.

Here is the kicker.....Had she not defaulted (maybe borrowed from bank or relative to make payments), she would have qualified for EIC this year and her refund would have been over $3,500.00.....Now, the $18,000 puts her out of EIC and she owes $3,400!!