Timing Is Everything - Deemed Distribution from Qualified Plan

An Elba couple recently found out that, when determining the taxability of a deemed distribution from a 401(k) plan, their domicile at the time of the deemed distribution, not their domicle at the time the loan that gave rise to it was made, is what counts.

Here are the facts: Jack and Janice Bell moved from Elba to Kentucky, and while living there in 1994, Janice took out a loan from her 401(k) plan at work, agreeing to pay the loan back through a payroll deduction program. She became ill in 1994, and defaulted on the loan. The Bells moved back to Elba in 1995, and in 1998, her employer put her on long-term disability and reclassified the loan as a distribution from the plan.

Is It Taxable In Alabama?

The tax preparer the Bells hired to prepare their 1998 Alabama return included the deemed distribution from the plan in taxable income. Mr. and Mrs. Bell filed their Alabama return with this entry on it, but did not pay the tax due. The Department of Revenue subsequently assessed them for the tax as well as interest and penalties. Mr. and Mrs. Bell appealed.

In the hearing before the Administrative Law Judge, Mrs. Bell told the ALJ that it was not fair to require them to include the distribution in Alabama taxable income, since they had been residents of Kentucky at the time they received the funds. Judge Thompson ruled that where they were living at the time the money was deemed to be distributed from the plan was what governed. Since Mr. and Mrs. Bell were Alabama residents at the time of the deemed distribution, the distribution was Alabama taxable income.

Jack and Janice Bell v. State of Alabama Department of Revenue, Docket Number 03-882.Issued 2/23/04.

This page last updated 8/3/04

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