Gross Retirement Plan Distribution Taxable

If you have a plan loan outstanding and take a distribution that’s partially used to pay off the loan, are you taxed on the gross amount or the net amount (gross amount minus loan repayment)? That was the question put to the Tax Court by an individual who closed out her retirement account. She had two outstanding loans from the account, which was maintained with an insurance company. Following the terms of the loan contract, the insurance company used funds from the account to repay the unpaid balance of the outstanding loans; the rest of the account, less income tax withholding, was deposited into her bank account. The Form 1099-R she received showed the gross amount of the distribution to which she was entitled when she closed the account, but she reported only the funds remaining after the loans were paid off.

The Tax Court said the gross amount of the distribution was includible in her gross income (Edgar Perry, TC Memo 2018-90). She effectively received the gross amount because it was as if she received it all and then used part of it to pay off the loans as required. The insurance company took a shortcut pursuant to the loan contract by applying the funds toward the balance and then refunding her what remained after income tax withholding, but this does not change the tax result. The taxpayer’s arguments to be taxed only on the net amount were found to be “without merit, irrelevant, and/or moot.”