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Merlo, Accountant
Category: Tax
Satisfied Customers: 9783
Experience:  25+ years tax consulting. Specializing in returns for US citizens living abroad
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I got an email from Putnam Investments stating that I need

Customer Question

I got an email from Putnam Investments stating that I need to pay $6,366.60 (past due) to bring my first-time home purchase loan of $40k (current balance $25k) up to date and resume loan payments via payroll deductions (it was on freeze for about 18 months due to my company transition period) OR default the loan and pay taxes! What are the tax ramifications? What are my rights? This will bring financial hardship on me! I don't know what to do.
Submitted: 6 years ago.
Category: Tax
Expert:  Merlo replied 6 years ago.

Hello Customer,


How long ago did you purchase this home and how long have you lived there?



Customer: replied 6 years ago.
I purchased the house in September of 2001. I'm stll living in my home.
Expert:  Merlo replied 6 years ago.

Hello again Customer,


Thank you for the additional information.


Normally when you have a debt that is canceled or forgiven, you are responsible for paying taxes on the amount of the forgiven loan. That is what Putnam was referring to when they said you would have to pay taxes on the defaulted loan.


However, due to the recent mortgage lending crisis in our country, Congress has enacted temporary legislation which allows taxpayers to exclude canceled debt from a foreclosure on their primary home from being taxable income.


The Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude certain canceled debt on your principal residence from your income. It applies to mortgage debts that are canceled or modified during the calendar years of 2007 through 2011 . You would still receive a 1099-C form from your bank showing the amount of the debt that was canceled, but you will file Form 982 which you attach to your tax return, and claim an exclusion for paying taxes under this new law.

You simply need to file Form 982 with your tax return. Check the box on line 1e showing that you are claiming exclusion of debt on your principal residence. And then on line #2, enter the amount of the canceled debt as shown in box #2 of the 1099-C form. You will then not need to pay taxes on this forgiven debt.

If this was helpful please press the Accept button. Positive feedback is also appreciated.
Thank you Customer



Customer: replied 6 years ago.
No. The loan is from my 401k.
Expert:  Merlo replied 6 years ago.

Hello Customer,


Sorry, but you did not provide that information in your initial post, and I just assumed this was a regular mortgage.


Loans you took from your 401k account fall under a whole separate set of rules. When you take a loan from your 401k plan, you are required to pay back the loan in accordance with the terms set forth by the employer. During the months that payroll deductions were not made, you should have still made arrangements to pay your monthly loan payments on this loan.


If the loan is not brought up to date, then the 401k plan administrator is required to report the outstanding amount of the loan as a taxable distribution made to you, and you would owe taxes on that amount. This would be taxed as ordinary income, so the actual percentage of tax you end up paying would depend on your filing status and your total other income for the year, as this is what determines the tax bracket you are in.


In addition, if you are under the age of 59-1/2, then you would also owe an early withdrawal penalty of 10% in addition to the regular income taxes that are due.


There is really nothing you can do to avoid this situation other than pay the balance you owe to bring your loan payments up to date. You may want to consider taking out a home equity loan or a loan from another source to pay up your 401k loan to avoid this taxable situation.


If this was helpful please press the Accept button. It is the only way we receive any credit for helping with these questions.


Thank you



Customer: replied 6 years ago.
I won't be able to take out a home equity loan because my home is below what I owe (under the water)... Cry

This is not really helpful... in the letter it stated that "If you are under age 59/2, an additional 10% early withdrawal penalty may apply." The operative word here is "may"... how's that? What's the option to avoid the penalty? Wouldn't I be able to ask to waive the penalty based on Obama's program on housing solution?

For what's worth, I am deaf. I am 50 years old. This year will be my last year to file as head-of-household since my 18 year old daughter just graduated from high school and just moved out.

Expert:  Merlo replied 6 years ago.

Hello again Customer,


I am sorry if you did not find this answer helpful, but I can only provide you with information based on what the laws are. I cannot provide alternative solutions to you which do not exist. If there was a way for you to avoid paying taxes on this distribution other than bringing your loan account up to date, I would be more than happy to provide you with that information.


The letter which said the early withdrawal penalty "may" apply is simply a form letter where they use generic language, as they do not know how these funds were used. The IRS allows the 10% early withdrawal penalty to be waived only if the funds are used for one of the following reasons:


  • Distributions upon the death or total disability of the plan participant.
  • You were age 55 or over and you retired or left your job.
  • You received the distribution as part of "substantially equal payments" over your lifetime.
  • You paid for medical expenses exceeding 7.5% of your adjusted gross income.**
  • The distributions were required by a divorce decree or separation agreement ("qualified domestic relations court order")

    You used these funds for the purchase of a home, so there are no exceptions in your case which apply to the early withdrawal penalty.


    You can always request that the early withdrawal penalty be waived, but I can guarantee you it would not even be considered unless it meets one of the above exceptions. The IRS has these rules in place and they must be followed. They do not make exceptions on a case by case.







    Edited by Merlo on 9/1/2010 at 6:38 PM EST