In June 2006, I took a loan against my 401(K) for a downpayment on a home. In July 2006, I left my previous employer. I had expected my employer to provide instructions on what to do about the loan. As I prepared my taxes in December of 2006, I called Vanguard about the loan since the funds had not been reduced from my Vanguard fund balance. I was told that my employer did not have any policies regarding loan repayment upon termination and that I should wait to hear from my previous employer.

Since I did not hear from my previous employer, I waited to see what appeared on the 1099-R in 2007. I never received one. Mid-way in 2007, I saw that my funds dropped by the loan amount. I still received nothing from my employer. However, when I left under difficult circumstances, I was told that the company would make certain that they would do all possible to make certain no financial harm resulted in my leaving. Therefore, I assumed they must have taken care of the matter.

April of this year, I received a letter from the IRS requesting payment of back taxes and underpayment penalty.

I know that I would have paid these taxes if the loan was defaulted. However, I was not certain that I had actually defaulted on the loan. Is there any recourse not to convince the IRS that I honestly did not know I had defaulted on the loan?

Obviously, the IRS received a copy of the Form 1099-R, or you would not have gotten the letter.

Contact the IRS, explain that you never received the Form 1099R, and ask to have the under-payment penalty waived (by law, they CANNOT waive any interest charges). You can also set up a payment plan if necessary.