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Employee who Embezzled Funds - Are we required to withhold 20% on dist


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#1 J Samuelson

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Posted 11 November 1999 - 02:14 AM

An employee embezzles money from his/her employer. In a settlement, the embezzler agrees to sign over their vested 401k balance. (The proper paperwork for a distribution is being completed. The check will be written from the trust's checking account to the participant, who will sign their check back to the employer.) I know I'm fishing, but is there anyway not to withhold the 20% for taxes? Employee is under age 59-1/2.

#2 Dave Baker

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Posted 11 November 1999 - 04:49 PM

Talk about rubbing salt in the wound. The employer in effect is paying the embezzler's income taxes. Sigh.

One option (?) - the heck with the withholding requirement. What's the sanction? It might be worth it, to the employer/administrator.

#3 Guest_named__*

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Posted 11 November 1999 - 05:31 PM

The sanction is that the plan administrator (presumably the employer) is subject to underwithholding penalties (which can silently mount to mucho dollars quickly). Moreover, we can assume that the former employee is probably a tax deadbeat as well and didn't pay any taxes on the distribution. This means the employer will owe the full 20% with no offset for the tax paid by the employee ($0).

Now talk about rubbing salt in the wound -- the employer ends up paying the embezzeling employee's taxes on the distribution! Ouch! Given the character of the deadbeat employee, the employer would be nuts not to withhold.

P.S. The employee will also owe the 10% early distribution penalty if he isn't 59.5 or not eligible for any exception.

P.S.S. I hope the employer had a lawyer look at this arrangement. You'd hate to have the employee come back a few years later and argue this was a prohibited assignment / forfeiture of benefits . . .

#4 J Samuelson

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Posted 11 November 1999 - 06:09 PM

An attorney is drawing up the agreement. It was just wishful thinking hoping they'd get 100% of the 401k instead of 80%. The employee will receive a 1099-R with Code 1 for early distribution and will have to pay tax and penalty sometime since it will be reported to the IRS.

#5 pax

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Posted 11 November 1999 - 07:09 PM

I hope this is not a stupid question.
Could the agreement be drawn up so that the entire distribution is done as a direct rollover (to a new IRA with no other funds), and the EE then withdraws the entire amount and signs it over to ER? I think the tax to the EE is the same.



[This message has been edited by pax (edited 11-11-1999).]

#6 Dave Baker

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Posted 16 November 1999 - 12:09 PM

I like it, pax. Maybe get the individual to sign a letter to the IRA custodian authorizing the upcoming cash withdrawal by the employer?

Re the original assignment idea - I've never been comfortable with anything in writing between the employer and employee in these situations. I'd worry about disqualification on grounds of a violation of the anti-alienation rule. I've told employers to tell the embezzler that he/she can damn well make an appointment to come in to the office and pick up the check in person (rather than mailing). Then I tell the employer to have the plan's check (less the 20% withholding) made payable from the trust to the embezzler. Then the employer looks the embezzler in the eye and says "I'd like you to endorse the back of this check over to the employer, in partial repayment of your debt to the employer." Note the careful wording "I'd like you to..." Illegal to say "You are not getting this check until you endorse the back of it..." etc. If the embezzler balks and wants the check, you've got to give it to him. But before giving the embezzler the check the employer has a chance to lecture the individual on why it is in his/her best interest to endorse it over to the employer. "We're not going to stop coming after you until all of your debt to the company is paid; you screwed up and you owe it to yourself, your God, and to us to repay the debt to the extent you can, including endorsement of this check over to the employer; your voluntary endorsement of this check over to the employer might be taken into account by the authorities in determining the extent of your civil or criminal punishment," etc.