It seems that the 1099R belongs to her brother. I think she can show it on her tax return and offset it by issuing a 1099R to her brother with a copy to the IRS. Do some research to make sure I am correct. The insurance company was probably correct in how they handled the situation as the loan was probably to the policy holder and the policy holder loaned the money. Another possibility is you might be able to write off the loan as a bad debt investment and not involve the brother. Just some guesses that some one may comment on.
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