Expert: Allen - 9/15/2009

Question
A $50,000 loan was obtained from a pension plan 5 years ago. Payments were made for the first couple years following the repayment schedule. After the first couple years payments have not been consistant. The loan is now over 5 years with a balance due and the employee cannot pay off the loan due to financial hardship.

1) Is the employer/trustee required to report on a 1099 the unpaid balance as a distribution to the employee?

2) Is there a financial hardship exclusion?

Answer
The loan is considered taxable when the participant has not made payments for two consecutive calendar quarters. Therefore it sounds like the loan went into default several years ago and a 1099 should have been issued at that time. Even though the loan became taxable, it must be repaid and the trustee is obligated to seek payment. If this was not done and loan should have been reported, I would prepare a 1099 for 2009. Note that the participant then has what is known as basis and does not have to pay tax the second time the amount that is repaid to satisfy the loan is paid out again.

There is no hardship exception to the requirement to repay the loan and to report it as taxable income. However, if the plan has a provision allowing for distributions in the event of a hardship and the participant satisfies the conditions for a hardship, then he or she can take a distribution. The rules are too complex for me to cover in a free service. You therefore should discuss this with whomever helps with the administration of the plan or the investment of plan assets.