403(b) Loan Defaulted; 1099-R Issued

[btw_tax]

My wife's company was moved to a different company, thus terminating her employment with the original company in Sept 2019.  She had an outstanding loan with her 403(b) plan.  She either ignored or didn't see the notices from Fidelity that something had to be done about the loan, which i was unaware of.  So, in Jan 2020, I receive a 1099-R form with 1L in box 7 saying the loan balance ($18k) is being treated as a distribution and we are liable for the taxes (fed, state, early withdrawal, etc).  I read that with the  Tax Cuts and Jobs Act of 2017 that we had until April 15, 2020 to repay the loan.  So, my wife calls Fidelity and they pull the loan balance from our checking account plus interest ($19k) in Feb 2020.  I see on her Fidelity account that they money went back in as "Loan Repayment".  I didn't see another 1099-R generate or any other statement come through so I called Fidelity.  They tell me that we are still have to pay taxes on the distribution and the loan repayment has to stay in the 403(b) plan.  Only reason for the repayment was to avoid the tax on the distribution.  Very confused on how we still have to pay taxes when the loan was paid back and why they we were allowed to repay the loan if it was going to still be treated as a distribution.  So, instead of owing an extra $8k in taxes on the distribution, we are also out $19k for the payback which they say is treated as pre-tax dollars even though they pulled it out of my checking account.  I demanded the loan repayment be rolled back but they don't appear to be budging.  Need help on this!

[dmertz]

The extension of the deadline to the due date of the tax return, including extensions, for rolling over a loan treated as a distribution only applies to offset distributions (code M in box 7), not to deemed distributions (code L in box 7).  A deemed distribution does not satisfy the loan and the loan remains subject to repayment.

The question then becomes, why was this distribution a deemed distribution rather than an offset distribution?  That's a question for the employer.  It must be a deemed distribution if your wife was not eligible to receive distributions from the plan at the time that the distribution was required to occur due to still being considered employed by the employer providing the plan.  She would have only been eligible to receive a distribution if she was considered to have separated from service from the employer providing the plan.  Perhaps a default occurred before the change of employer, in which case i must be a deemed distribution.  However, if the plan considers the loan to have been satisfied, it must have been an offset distribution and the Form 1099-R is coded incorrectly.

[btw_tax]

It didn't consider the loan to be satisfied until we repaid it last week, after I had already received a 1099-R with 1L in box 7.  If the new tax law only applies to offsets, why would Fidelity allow us to pay back the loan in 2020 when there is no benefit in doing so?  Just very confusing that they took the money to pay back the loan and we are still on the hook to pay taxes on the distribution even though we have put that money back into the 403(b).  We should have never repaid the loan and it doesn't appear there's a way to roll back that payback.

[dmertz]

A deemed distribution causes the distribution to become taxable but does not satisfy the loan and does not reduce the balance to the credit of the employee.  The loan remains as one of the investments within the 403(b) account.

Because taxes have already been paid on the amount of the deemed distribution, subsequent repayment of the outstanding loan balance become after-tax basis in the 403(b) and will not be taxed again when later distributed from the 403(b).  This just means that the taxes on this money are paid now rather than later.  Because the balance to your wife's credit in the 403(b) was never reduced, nothing was ever paid out that could be rolled over.

[btw_tax]

If the money that went back into the 403(b) is deemed after-tax and will not be taxed again, shouldn't I be able to pull that money back out now?  Didn't know after-tax money could go into a pre-tax retirement account.  I get that loan repayments are after-tax dollars, but that makes sense because you don't pay taxes on the loan distribution.

[dmertz]

The after-tax money in the 403(b) might be held in a separate sub-account and, depending on the plan provisions, might be eligible to be distributed separately before separation from service or reaching age 59½, but that's a question for the plan administrator.