Will my defaulted loan against my 403(b) retirement account be added to my gross income for the year?

by Lesley F. Katz, CPA | Nov 17, 2017

I recently switched jobs, and I had a loan out against my 403(b) retirement account. The loan defaulted. I know that I will be paying federal and state taxes plus a penalty. Will the amount of the loan be considered additional personal income, and, therefore, added to my gross income for the year? I ask because, if added, this loan may put me into a higher federal tax bracket.

The first step I suggest is to obtain the 403(b) plan document and look for clauses that address loans from the 403(b) plan. There may be specific terms about how 403(b) loans are to be handled when someone leaves the company and, by default, the 403(b) plan.

If there are no specific terms, the state and federal taxing authorities are likely to classify the loan as a premature distribution from the 403(b) plan. As such, if you are younger than 59.5, then there are interest and penalties assessed. The amount of the loan is considered ordinary income on your tax return in the year that it is designated as a distribution of income -- likely the year you leave the job and the 403(b) plan. It will appear on page 1 of Form 1040 as a distribution from a retirement account.

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Answered by: Lesley F. Katz, CPA, is the founder of Leveraging Financial Knowledge LLC in Lower Gwynedd, Pa.
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