Participant's Tax Ramifications on Defaulted Loans

A Plan loan, which is in default, will be treated as a deemed distribution for tax purposes. The deemed distribution (defaulted loan) will be included in income on the plan participant's tax return. In addition to the income taxes on the deemed distribution (defaulted loan), it might also be subject to the penalty tax on early distributions. Unlike the income taxes which would be calculated at the individual's applicable tax rates, the penalties, if applicable, would be at 10% and 2 1/2% for federal and California respectively. The actual deemed distribution would be reported to the plan participant and the Internal Revenue Service on Form 1099-R. There are, however, several exceptions to the penalty rule. Participants should consult with their own tax advisers concerning how defaulted loans will affect them personally.