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I understand that if you don't repay the loan the unpaid balance becomes a taxable distribution plus penalties. But if all contributions to the 401(k) were after tax contributions, do you have to pay tax on that portion or just on the earnings? Does anyone know which of the IRS Publications addresses this issue?

Thanks very much.
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I understand that if you don't repay the loan the unpaid balance becomes a taxable distribution plus penalties. But if all contributions to the 401(k) were after tax contributions, do you have to pay tax on that portion or just on the earnings? Does anyone know which of the IRS Publications addresses this issue?

Tricky, mostly for the plan administrator, more so than you. Assume you took a $50k loan from your account & at that time of the loan there was $200k in the account of which $40k was ltd after-tax contributions and $160k was ltd earnings. In the intervening time, you pay down loan to $40k and then default the loan thus creating a distribution.

You will be deemed to have a distribution of $40k of which you have a $8k ($40k * 40/200) basis in the distribution. A return of basis is not includible in gross income & is not taxed. Conversely, the $32k is includible in gross income and is therefore taxed at regular income tax rates; plus the §72(t)(A)(4) 10% penalty.

You can find lots of detailed examples of similar transactions to this in Publication 575. The real key here is to get the plan administrator to properly prepare the 1099R it sends you at the end of the year. Box 1 should say $40k & box 2A should say $32k.

TheBadger


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You will be deemed to have a distribution of $40k of which you have a $8k ($40k * 40/200) basis in the distribution. A return of basis is not includible in gross income & is not taxed. Conversely, the $32k is includible in gross income and is therefore taxed at regular income tax rates; plus the §72(t)(A)(4) 10% penalty.

You can minimize the penalty and tax, if you can refund an IRA within 60 days of the date the distribution is deemed to have been made on the balance of that loan.

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