1099-R received from unpaid 401k loan balance

[ivatan]

I received a 1099-R for the unpaid balance of my 401k loan from my previous employer. My 401k account both has traditional 401k and Roth 401k. Is there a way I can enter the information from my 1099-R as having been withdrawn from my Roth 401k so I am not taxed heavily? Is there a way to show that it came from my Roth 401k account where my contributions there were taxed already? Thank you for any advise you can give.

[Opus 17]

No, you can’t move the balance around. If the loan was taken from the pre-tax account, that is where the 1099R comes from. That would’ve been determined by your plan’s policies and the loan documents that you  originally signed.

However, you should be aware of a new provision in tax law. When you have an offset distribution that results from defaulting on a plan loan after leaving employment, you have until the following year’s tax deadline to make a rollover contribution to a new account. Funds that you roll over are not taxed.

This means that you have until April 18, or October 15 if you get the automatic extension, to make a rollover contribution to a private IRA or to the qualified retirement plan at your new workplace.  For example, the outstanding loan balance was $10,000 and you can afford to re-pay $6000 by October 15, then you would have a $6000 rollover and the taxable part of the offset distribution would only be $4000.

Because you will pay an additional 10% penalty for early withdrawal if you are under age 55, it may be worth it to take out a short term loan to gather the funds needed to make the rollover contribution.  A rollover contribution is not a regular contribution and is not subject to the normal limits, but it is also not tax-deductible. You would have to inform the receiving plan that this is a rollover due to an offset after termination, because most rollovers must be completed within 60 days and you are well past that.

[ivatan]

Thank you for the information about having until tax deadline to rollover my unpaid 401k loan balance. This would greatly help with my tax situation. Can you share a link from the IRS website or tax resource website showing this information so I can refer to it when I go to my new employer's 401k plan administrator? Thanks again.

[ivatan]

I found the IRS webpage that explains this. It looks like I can do the plan loan offset amount rollover is the distribution code (box 7) of my 1099-R shows "M". However, the code that shows in box 7 is "1". Can I still do this rollover to an IRA account? How?

[Opus 17]

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@ivatan wrote:

I found the IRS webpage that explains this. It looks like I can do the plan loan offset amount rollover is the distribution code (box 7) of my 1099-R shows "M". However, the code that shows in box 7 is "1". Can I still do this rollover to an IRA account? How?

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@dmertz  do you have any comment?

I believe the 1099-R should have had both code 1 and code M (M1 or 1M).  

I would start by asking the plan to send a corrected 1099-R.

I don't think the new plan will ask to see the 1099-R.  If you had made the rollover contribution before the 1099-R was issued, you wouldn't have one to show.  I don't know what other proof the new plan might want; they might only want your signature attesting to the offset distribution, or they might want to see your loan documents, but I don't think they will want to see the 1099-R.

Where the lack of a code M could cause trouble is with the IRS, if their computers get around to matching the different forms (in this case, they would have to match the 1099-R from the old plan with the form 5498 from the new plan, in which case they might call it an unallowed rollover).  You would get a letter from the IRS asking for an explanation, and you would reply with copies of documents showing that it was an offset distribution due to termination.  It would help in this instance to have a copy of a letter you sent to the plan asking for a corrected 1099-R.

But I would not delay making the offset rollover while you wait for the corrected 1099-R.  I think you are still ok to make the offset rollover even though the plan didn't use the right code, as long as you can prove to the IRS that it really was an offset distribution. 

[dmertz]

Code M is used when there is a qualified plan loan offset.  If the loan had been maintained in good standing prior to separation from service, I don't know why the plan wouldn't consider the offset distribution to be qualified.  Perhaps the plan simply made a mistake in omitting code M from box 7; the plan should be asked about that.  (Code M has only been in existence since 2018 and some plans may still be ignorant of this change in the tax code.)

To be a qualified plan loan offset, the offset distribution is solely by reason of the termination of the qualified employer plan or the failure to meet the repayment terms of the loan from such plan because of the severance from employment of the participant (the latter in this case).

[ivatan]

Thank you, @Opus 17 and @dmertz !

I have just sent an email to my former employer's 401k plan administrator and requested the distribution code be changed to "M". I hope I get a response quickly and before the tax deadline on April 18.

[Opus 17]

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@ivatan wrote:

Thank you, @Opus 17 and @dmertz !

I have just sent an email to my former employer's 401k plan administrator and requested the distribution code be changed to "M". I hope I get a response quickly and before the tax deadline on April 18.

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As I mentioned before, I believe you are legally entitled to perform the rollover if you are qualified, even if the code on the 1099-R does not agree.  On the question of whether your offset was "qualified" or not, that is covered in @dmertz 's comments.

Second, if you insist on waiting to do the rollover until you get a corrected 1099-R, you should apply for the automatic extension to file your tax return.  This will give you until October 15 to complete the rollover and file your return.  Even though the extension is automatic, you still must actually apply for it. 

[dmertz]

I suggest requesting a filing extension to ensure that the rollover deadline is moved out to October 15.  You'll still need to pay any balance due by April 18.  [Oops, I see that Opus 17 already suggested that.]