1099-R for Qualified Loan Offset distribution for deceased spouse

[Love2Cruise]

Clients spouse passed away in May.  Client received a 1099-R to the spouse (not to estate) for loan offset distribution in Thrift Savings Plan.  Does the 1099 get filed on 1041 or 1040?  Technically there is no estate as the spouse was the beneficiary of the TSP and all other assets were co-owned thus negating any kind of estate.  Some CPA websites says to file with 1041 because the 1099 was created after death.  In this case,  since there is no estate, who pays the taxes?  If filed on 1040, spouse would have to pay the taxes on loan that she was not legally liable for to begin with.  The offset reduces the amount of the TSP account so in theory, the spouse is being penalized for the loan. 

I've researched the IRS regs and various other areas, including some CPA input, but can not come up with clear concise direction.  The IRS does not address this area specifically that I can find.  Any input from someone with direct experience or knowledge of this situation would be greatly appreciated.

[TaxGuyBill]

It probably doesn't really matter.  🙂

I would probably put it on the 1040.

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@Love2Cruise wrote:

In this case,  since there is no estate, who pays the taxes?  If filed on 1040, spouse would have to pay the taxes on loan that she was not legally liable for to begin with.  The offset reduces the amount of the TSP account so in theory, the spouse is being penalized for the loan. 

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If the spouse files a Joint return, the spouse is claiming responsibility for the amount owed.  Otherwise, it would would come from his assets ... which would effectively mean it is coming from the spouse anyways.

[Love2Cruise]

I see your point.  The 1041 taxes the income at a higher rate.  So amending and filing on the 1040 is a no-brainer, if it doesn't matter.  I appreciate your input. Thanks much!

[BobKamman]

@Love2Cruise "Technically there is no estate as the spouse was the beneficiary of the TSP and all other assets were co-owned thus negating any kind of estate."

For 1041 purposes, there can be and often is an estate.  I would compare this to a situation I recently had, involving a decedent with about $10,000 in 1099-C cancellation of debt income.  You wouldn't tax that to a beneficiary.  I suspect your 1099-R was issued because the surviving spouse provided her SSN when a withdrawal was made from the TSP, either to her directly or to a rollover account.  If you fought long and hard enough, a corrected 1099-R might be issued.  But it's easier to report it on her 1040 as received, but not taxable.  

If the 1041 is the right place to report the "income," it shouldn't be a question of who pays less tax.  The tax would probably be less if the income were taxed to his 10-year-old granddaughter, but you can't do that either.  But who is liable for paying the 1041 tax?  Maybe IRS Collections could reach the joint assets in the widow's name, but that's a separate question involving federal and state law.  And maybe the tax is less because there are deductions available on the 1041.  

[Love2Cruise]

So are you saying it should have been issued to the spouse when she rolled the inherited account over? The 1099-R was issued when the loan was essentially closed and treated as a distribution.  But if the spouse indeed has to pay the tax on the distribution, it is to her benefit to file on amended 1040, as that's where the tax is less. There was a 1099-C issued for a credit card, which I agree with filing on the 1041. 

There aren't any credible deductions to use on the 1040, unless I've overlooked something.  There was no distribution of assets to any beneficiaries, other than the TSP.  And the only deductible fees are the administrative fees for setting up probate, which was required to get two small accounts (less than $1500) transferred to the spouses name.

I really appreciate your input.  Hate these type of scenarios. 

[qbteachmt · Accepted solution]

You have probate, but state there is no estate. But probate is used to settle what is in an estate and outside of a beneficiary arrangement. So, you have an estate?

This isn't really worded correctly: "If filed on 1040, spouse would have to pay the taxes on loan that she was not legally liable for to begin with."

The Loan was from that account, which makes it hers, now. Date of settlement makes it hers, as the account became hers, when the transfer to the beneficiary was settled, because of his death.

If this 1040 is on extension, there still is time to rollover the amount of the loan offset for tax management purposes: "Effective January 1, 2018, if the plan loan offset is due to plan termination or severance from employment, instead of the usual 60-day rollover period, you have until the due date, including extensions, for filing the Federal income tax return for the taxable year in which the offset occurs."

From: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans#2

Otherwise, the amount is considered to be a taxable distribution, which was settled to her.

[Love2Cruise]

Thank you for the correction on my wording and the clarification.   I guess there is an estate since the two small bank accounts were settled outside of beneficiary arrangements.

The 1040 has already been filed.  These items came up afterwards.  An amended return will have to be filed.  Question is, since the return has been filed, can she go ahead and roll over the loan offset and include on the amended return.  

Much appreciated.

[qbteachmt]

Read this:

https://www.irs.gov/publications/p721

And it refers you to Pub 575 for Timing of rollovers.

My point for the "loan" is, you were stating it as if the borrower benefited from the money, so the borrower (or his estate) should be reporting that as income and paying the tax. But it is not treated the same as forgiven debt (deemed distribution). This is treated the same as (Taxable) Actual Distribution. Distribution because, as part of closing out the account to the beneficiary, it was the amount of the missing component. It's more like: to close out the account, we'll pretend we gave you the full amount, some of which you used to repay the loan, and you get the Net as the beneficiary.

[qbteachmt]

Of course, this has now become a topic for discussion around the home (home office). Here's another way to understand that difference and why this isn't a 1041 issue:

You borrow your own money in this case. That means not repaying it is Not a forgiven loan; it's a distribution of your money, and the "declared" date of the distribution is the 1099-R, which is issued because clearly, that is not being repaid into your account if you are dead and this is being given to a beneficiary.

[Love2Cruise]

THAT'S the component that was escaping me.  Tunnel vision had me blinded...you've helped me see it in the proper light. Duh!!! 😁 👍

Thanks so much for your input and direction!!!

[BobKamman]

I'm not finding anything in Pub 721 or 575 about repayment of loans to deceased TSP participants, but maybe I'm not looking in the right place.  

Are you saying that if the TSP beneficiary had been the 10-year-old granddaughter, and the loan of $25,000 was paid off before she got the $5,000 that was left, the kid would have to pay tax on $30,000 income?  

[qbteachmt]

"about repayment of loans to deceased TSP participants"

Let's try another perspective:

Two scenarios.

1.

You have an account with $1,000 in it. You ask to borrow $500 from me pointing out you have an account that can secure this loan. Then, you spend all that money and what is in your account and go broke and can never repay me. I forgive your debt to me. Your total of funds available and spent was $1,500: My $500 and your own $1,000. You "made money" and that is why forgiven debt is income to you.

That is Loan Forgiveness. It involved additional funds and that component never gets repaid. You benefit.

2.

You have an account with $1,000 in it and ask me to give you some of it on a temporary basis. You are supposed to be repaying it, and the terms mean we don't consider it a Distribution at that time. But you don't repay it, because you Die.

Your beneficiary is supposed to get your account balance. You didn't take a Distribution as such; you drew against it as a Loan. That's why it was not reported as Distributed yet. $500 was "forwarded" and $500 remains. I issue the reporting for $1,000, but there is only $500 to pay out now, because $500 was paid out earlier. The first payout is just now being reported for purposes of Distribution, because just now is when it is determined (being "declared") there will be no payback of that loan, which really is your own Advance. You borrowed from yourself, so there is no additional amount.

The total involved here is $1,000. It's a timing issue. This is why it is called an Actual Distribution and not a Deemed Distribution in the IRS literature. It is a distribution, but with delayed reporting.

"and the loan of $25,000 was paid off before she got the $5,000 that was left, the kid would have to pay tax on $30,000 income?"

If the loan had been fully repaid to that account, then No. The kid would get $30,000. There would not be only $5,000 left. Remember, you borrow from yourself. The original account holder would not have seen it reported as a Distribution, as long as the repayment process to himself proceeded to completion.

"but maybe I'm not looking in the right place."

From Pub 721, pg 14: "Outstanding loan. If the TSP declares a distribution from your account because money you borrowed hasn't been repaid when you separate from government service, your account is reduced and the amount of the distribution (your unpaid loan balance and any unpaid interest), from traditional contributions and earnings, is taxed in the year declared."

TSP resources:

https://www.tsp.gov/publications/tspbk04.pdf

https://www.doi.gov/sites/doi.gov/files/migrated/flert/training/upload/Withdrawing-Your-TSP-Account-...

[BobKamman]

For $725 a year you can subscribe to the ASPPA’s “ERISA Online Book” (EOB). I found this quote from someone who does:

From the EOB, "If the participant has an outstanding loan at the time of death, the participant's death will usually result in an offset of the unpaid balance against the accrued benefit. The participant (or the participant's estate), not the beneficiary, will be liable for any taxes resulting from that offset, because the beneficiary is not a party to the loan agreement. The tax liability might be reported on the participant's final income tax return or on the estate's income tax return."

Above from EOB Chapter 7, Section XIV Part I

[qbteachmt]

Then it seems the 1099-R needs to be corrected.

[Love2Cruise]

That was always my thought process.