Expert: Vanessa D. Powell, CPA - 8/1/2009

Question
My company paid a 401K loan repayment in default of $1,000 from the bank account for a partner.  The partner will repay the company by deducting his paychecks in 4 payrolls, $250 each paycheck.  I will record the $1,000 to the bank account as a partner expense.  When the loan repayment is deducted from each of the partner's paycheck, what is the journal entry, DR and CR account name, each $250 should be recorded to?

Answer
Okay, this gets confusing because of all the liabilities back and forth and cross-wise.  Here's the basics:

When a 401(k) loan is in default, what usually happens is that the trustee or third party recordkeeper will deem it a distribution after a set period of time.  That means the participant (the partner, in this case) would receive a 1099-R at the end of the year as if he had withdrawn the money outright and never intended to pay it back.  Because this results in them usually owing money (since none was withheld for taxes and penalties), it's best to avoid this situation.

So, to avoid this, the partner worked something out with the company.  The company pays off the defaulted loan and now the partner has a NEW loan with the company and the old one, essentially, doesn't exist any longer.  So, think of it as if the company had just given a small loan for 1,000 to the partner and record accordingly, like so:

At origination:

Debit    Due from partner (NOT the expense account, otherwise your entries won't work.)  1,000
Credit   Cash (or whatever the bank account is called on the books)

At each payment:

Debit    Cash (bank account)  250
Credit   Due from partner          250

After all four payments, your due to/from account will be empty again unless you use it for other items.

Hope that helps.  Best of luck!