Following an audit of my 401k plan, the IRS requires me to repay several Prohibited Transaction Loans, along with accrued unpaid interest. Once these loans and interest are repaid, does the interest constitute basis in my account? I assume the principle (the original amount of the distribution) would be since I also have to take those distributions into income for the years theyt occurred and pay income tax on them.

Thanks,
2612cmr

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Originally Posted by delite

Generally 401k contributions are not included in taxable income. As such no basis. Interest paid on loan is required by regulation without indicating a factor for basis.

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What about the interest paid when the IRS requires repayment of principle and accrued unpaid interest on Prohibited Transaction loans that are deemed distributions?

First its not a good idea to piggyback your question on another thread. This can lead to confusion. So I've moved your question to its own thread.

The interest on a 401(k) loan is income earned by the investment. It is therefore taxable income when distributed. If there is an outstanding balance when employment is terminated, then the balance becomes a distribution subject to taxation as income and penalty.

{Threads merged}

Basis is NOT typically an issue with 401K and other tax-deferred accounts, because the distributions are taxed as ordinary uncome, NOT a capital gains.

I think his OP's question is whether any of the repayment of the loan principal or the interest he paid can be considered as "after-tax" money. The answer is no - the repayment of principal simply undoes the tax-free loan that was taken out, and the interest payment is considered earnings by the account. It's an interesting side effect that there is some double taxation of the interest payment - since it's paid by the account owner using his personal after-tax funds and will be taxed again later when he makes withdrawals.

ebaines:

You are probably correct. Unfortunately, mind reading is NOT a skill incumbent with tax preparation expertise, so when the client says "basis", I have a bad habit of interpreting basis for being what I have been taught it to be.