This one has me completely beside myself and still having a hard time swallowing this. Basically, my wife took a loan out from her pension 11 years ago for down payment on home purchase. We've been making the loan payments all along but in June 2014 we were literally 3 business days late with that month's payment, so they then considered the loan "in default" and are now being TAXED on the loan balance { which is still a substantial amount } and they are considering that loan balance as INCOME in 2014. so now we not only get NO REFUND but OWE the IRS a substantial sum, according to our tax preparer { one of the major tax preparing chains }. Thing is, we are still paying the loan off and they are cashing our checks! It's not like we made extra income in 2014 but are being taxed in a higher bracket regardless.

A loan that is in default is generally treated as a taxable distribution from the plan of the entire outstanding balance of the loan ,a deemed distribution. The plan’s terms will generally specify how the plan handles a default. A plan may provide that a loan does not become a “deemed distribution” until the end of the calendar quarter following the quarter in which the repayment was missed. For example, if the quarterly payments were due March 31, June 30, September 30 and December 31, and the participant made the March payment but missed the June payment, the loan would be in default as of the end of June, and the loan would be treated as a distribution at the end of September. Since you are borrowing from yourself, you will have to repay yourself through after-tax paycheck deductions; Interest continues to accrue on the outstanding amount of a defaulted loan. In addition, if the unpaid amount is not repaid within the applicable grace period allowed by the IRS, the Program will report to the IRS the outstanding amount of the loan and the outstanding interest as a taxable distribution, meaning it is subject to taxes and any applicable IRS penalties. After the loan is reported as a taxable event, it will continue as outstanding debt to the plan and continue to accrue interest. The taxable event does not extinguish the loan.so as your 401(k) plan or 403(b) plan has made loans that haven’t complied with plan terms about loans, you need to find out how you can correct this mistake. after there has been a deemed distribution,your tax basis under the plan is increased by the amount of the late repayments. You will need to contact the IRS and explain you want to settle your debt. The IRS may allow you to pay a lump sum or make payment arrangements. The IRS may offer you an Offer in Compromise, which is a settlement offer that will stop interest and penalties from accruing on the tax debt you owe. You can stop interest and penalties by filing a tax abatement, which will stop future interest and penalties from accruing on your tax debt. You can apply for a tax abatement by downloading Form 843 from the IRS website You will need to complete it in full and submit it to the IRS for approval. Tax abatements are often accepted if you are experiencing a hardship where interest and penalties will prevent you from being able to pay your tax debt.you may ask your tax pro in your local area fro help.