What Happens to a Defaulted 401(k) Loan Under the CARES Act?

A defaulted 401(k) loan under the CARES Act usually received no special tax relief. The law let plans suspend loan payments due between March 27 and December 31, 2020, which kept many loans out of default in the first place. But if your loan actually crossed the line and became a “deemed distribution,” IRS Notice 2020-50 explicitly excluded it from the favorable coronavirus-related distribution (CRD) treatment, meaning you owed ordinary income tax on the full balance, plus the 10 percent early-withdrawal penalty if you were under 59½.¹ A different kind of default event, called a plan loan offset, did qualify for CRD treatment. Which one you had controls everything that follows.

Two Kinds of Default, Two Very Different Outcomes

Not every 401(k) loan default looks the same to the IRS, and the CARES Act drew a hard line between them.

A deemed distribution happens when you miss payments and blow through your plan’s cure period. The maximum cure period allowed under federal regulations runs through the last day of the calendar quarter after the quarter in which you missed the payment, though a plan can set it shorter.² Miss a payment in February, and you have until June 30 to catch up. If you don’t, the entire outstanding balance (principal plus accrued interest) is treated as distributed to you for tax purposes, even though no money moves. The loan itself stays on the books, and you still owe it to the plan.

A plan loan offset is different. Here, the plan actually reduces your account balance to pay off the loan. This usually happens when you leave your employer and the plan calls the loan due. Money genuinely leaves the plan’s accounting for your benefit, which makes it an actual distribution.³

The distinction sounds technical, but it is the whole ballgame. Deemed distributions were locked out of CARES Act relief. Plan loan offsets were not.

What the CARES Act Actually Did for Loan Borrowers

The main loan-side relief was a payment suspension. For both new and existing loans, plans could suspend repayments due between March 27 and December 31, 2020, for up to one year. While payments were suspended, the loan was not treated as being in default, so no deemed distribution occurred. Interest kept accruing, and when payments resumed the loan was re-amortized, with the maturity date pushed back by up to one year.⁴

Two caveats mattered. Plan sponsors had to adopt the relief by amending their plan documents, and not every plan did. And only “qualified individuals” could use it, meaning you needed to have been financially affected by COVID-19 through a diagnosis, job loss, reduced hours, lack of childcare, or closure of a business you operated.⁵

The suspension was designed to prevent a default. It did nothing for borrowers whose loans had already gone past the cure period.

Why Deemed Distributions Got No CRD Relief

Many borrowers assumed that if their 401(k) loan defaulted during 2020, the resulting tax hit would qualify as a coronavirus-related distribution and pick up the CRD benefits: no 10 percent early-withdrawal penalty, income spread across three tax years, and a three-year window to recontribute the money and reverse the tax entirely.⁵ That assumption was wrong.

IRS Notice 2020-50 listed deemed distributions under IRC Section 72(p) among the items that cannot be treated as CRDs.¹ The reasoning: a deemed distribution isn’t a real distribution. No cash leaves the plan. Since CRD treatment (particularly the rollover and recontribution mechanics) depends on actual money moving, a deemed distribution doesn’t fit the framework.

The practical result for anyone whose loan defaulted into a deemed distribution:

The full outstanding balance was taxable as ordinary income in the year of default.
The 10 percent early-withdrawal penalty applied if you were under 59½.⁶
No rollover was possible. Deemed distributions are not eligible rollover distributions.
No three-year income spread, and no recontribution path.

If you kept making payments after the deemed distribution, those payments built tax basis in the plan, so you’d owe less tax on an eventual real distribution. But the immediate tax from the deemed distribution was final.

When a Loan Offset Qualified as a CRD

If your 2020 default was actually a plan loan offset (most commonly because you left your employer with an outstanding loan), the picture was much better. Notice 2020-50 specifically confirmed that plan loan offsets could be treated as CRDs.¹

To get CRD treatment, the offset had to occur between January 1 and December 30, 2020, you had to be a qualified individual, and your total CRDs across all plans couldn’t exceed $100,000. If you cleared those bars, you got the full package:⁵

No 10 percent early-withdrawal penalty.
Income spread equally across 2020, 2021, and 2022 (or reported entirely in 2020 if that worked out better for you).
Three years from the day after the distribution to recontribute to an eligible retirement plan, treated as a tax-free rollover and not counted against annual contribution limits.

CRDs got reported on Form 8915-E for 2020. Repayments and the second and third years of the income spread moved to Form 8915-F, which replaced 8915-E as a recurring form across tax years.⁷⁸

How to Tell Which One You Had: Check the 1099-R

Your plan administrator’s reporting tells you which category your event fell into. On Form 1099-R, Code L in Box 7 identifies a loan treated as a distribution, meaning a deemed distribution. Plan loan offsets are not coded with L; they’re reported as regular distributions.⁹ A secondary code such as Code 1 may also appear if the early-distribution penalty applied.

If your 2020 1099-R carried Code L, your event was a deemed distribution and CRD treatment was not available to you. If Code L is absent and the form reports a distribution tied to your separation from employment or the plan’s termination, you likely had a plan loan offset, and CRD treatment may have been (or still may be) in play.

The Amended-Return Window That Is Still Open

The one piece of this that is still actionable concerns the three-year CRD income spread. If you took a CRD-eligible distribution or offset in 2020, elected the spread, and later recontributed some or all of the amount, you can amend prior-year returns to recover tax you paid on income that was ultimately returned to a retirement plan. The form is 1040-X.¹⁰

The IRS gives you three years from the date you filed the original return (or two years from the date you paid the tax, whichever is later) to claim a refund.¹¹ For 2022 returns, which carried the final year of a three-year CRD income spread, that window closes in April 2026 for returns filed on time. Miss it and the refund opportunity is gone.

Repayments that crossed tax years can be reported on the following year’s Form 8915-F or carried back by amending the prior-year return.⁸ The mechanics get tangled when repayments span multiple years, so pulling together every 8915-E and 8915-F you filed is the practical first step before amending.

For deemed distributions that never qualified as CRDs, there is no retroactive fix. That tax bill was final when it was assessed.

Current Loans Get the Standard Rules

The CARES Act’s loan provisions were temporary and are long gone. The payment suspension covered payments due through December 31, 2020. For any 401(k) loan you take or carry today, the standard rules apply: the lesser of $50,000 or half your vested balance, five-year repayment through substantially level quarterly payments (longer if the loan buys your primary home), and the same cure-period rules that existed before the pandemic.¹² If you leave your job with an outstanding loan now, the CARES safety net is not available. Repay by the plan’s deadline or face a taxable offset.

1
Internal Revenue Service. Guidance for Coronavirus-Related Distributions and Loans from Retirement Plans Under the CARES Act – Notice 2020-50
2
Internal Revenue Service. Issue Snapshot – Plan Loan Cure Period
3
Internal Revenue Service. Plan Loan Offsets
4
Internal Revenue Service. Coronavirus Relief for Retirement Plans and IRAs
5
Internal Revenue Service. Coronavirus-Related Relief for Retirement Plans and IRAs Questions and Answers
6
Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
7
Internal Revenue Service. 2020 Instructions for Form 8915-E
8
Internal Revenue Service. Instructions for Form 8915-F
9
Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
10
Internal Revenue Service. Amended Returns and Form 1040-X
11
Internal Revenue Service. Time You Can Claim a Credit or Refund
12
Office of the Law Revision Counsel. 26 USC 72 – Annuities; Certain Proceeds of Endowment and Life Insurance Contracts