Please see below the question I must answer. I know that she will have to pay tax on the money she will receive and she will have a pay a penalty as well but I am not sure why? Can you please provide an explanation as to why she will have to pay tax and a penalty on her 401(k) money?

Many years ago your client Lucy Hapless (currently single and age 48) started working with Sham Credit Swap (SCS) Inc., where she participated in the company s 401(k) plan. Five years ago, she took out a home loan from her 401(k) plan. The loan was repayable with interest through semimonthly payroll deduc-tions over a 10-year term. Lucy made the scheduled payments until she was laid off this early this year. The outstanding balance of the loan became due and payable at the time of Lucy s termination, but she did not have the money to pay off the loan, nor was she able to refinance it. No payments were made on the loan after her layoff, and the loan went into default. The 401(k) plan sent Lucy a letter, notifying her that she had a deemed distribution from the plan equal to the then unpaid loan balance of $72,000. The 401(k) plan sent Lucy a check for $98,000, which represented the balance of her plan account minus federal tax withholding of $24,500. Six months ago, after Lucy received the check, she deposited the entire $98,000 into her checking account and has been using the money for living expenses, because she has been unable find another job.