Accepted Answer

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.
(Reg. § 1.72(p)-1, Q&A-10(a))
A deemed distribution is treated as an actual distribution for purposes of determining the tax on the distribution, including any early distribution tax.

So if the distribution (as per your plan) is considered to be a deemed distribution for 2009 than you can save 10% early withdrawal penalty as as distribution taken after separation from service(Distributions made to you after you separated from service with your employer, if the separation occurred in or after the year you reached age 55 is an exception to the 10% early withdrawal penalty))

Let me know if you have any question.

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

Expert:	RD
Pos. Feedback:	99.4 %
Accepts:
Answered:	10/27/2009

Certified Public Accountant (CPA)

CPA, MBA, Over 10 yrs of experience in tax planning and business consulting..