A offset distribution is simply a regular distribution that goes to immediately satisfy the outstanding loan. The distribution is taxable unless you can come up with the money from another source to roll the offset distribution over to another qualified retirement account within 60 days of the offset distribution being processed. If it's an early distribution, (code 1 in box 7 of the Form 1099-R), the taxable amount of the distribution is also subject to a 10% early-distributions penalty. Unless it's in combination with a distribution paid to you, offset distributions do not have any taxes withheld since there is no cash from which to make the withholding. If your total withholding and estimated tax payments throughout the year were not sufficient, you could also owe an underpayment penalty.
