There has been a great deal written about why borrowing from your 401(k) plan is a bad idea. If you want to read a good case in point that illustrates how things can go awry when it comes to a 401(k) plan loan, read the recent Tax Court case of Tilley v. Commissioner. The participant in that case had borrowed from her 401(k) account to purchase a home, but when she was terminated, couldn’t pay the loan off. Even though the participant received a Form 1099R indicating that the unpaid loan balance was taxable, the participant failed to pay any additional tax on the distribution. The IRS ended up assessing tax on the loan balance, a 10% early distribution penalty as well as a 20% negligence penalty. After trying to allege that a call center representative for the provider had indicated that the distribution was not taxable, the Tax Court stated that it was not reasonable for the taxpayer “to rely on a. . . call-center representative for tax advice.” The participant was also hoping to obtain a waiver of the 60-day rollover requirement from the Tax Court, offering to put the money in an IRA, but the Tax Court declined:
Four years later, petitioners urge the Court to grant them a waiver of the 60-day requirement. See sec. 408(d)(3)(I). They argue that [the provider] made a mistake sending them the check and that they would now be willing to put the money into [the participant's] IRA. On these facts we decline to grant the waiver, and we do so without offense to equity or good conscience.
(The case was brought before the Tax Court under Internal Revenue Code section 7463 pertaining to amounts in controversy of $50,000 or less. That is why the opinion states that the case is not precedential.)