A participant rolled over his lump sum distribution into an IRA. Several months later, the employer has notified the participant that he was given too much money and the excess must be returned. The participant is willing to do what has to be done, but he is concerned that the distribution will be taxable to him. He should not receive a 1099R for this excess because the money is going back to the employer's plan, not into the participant's pocket. How should this be handled?

Generally, excess amounts, including those attributed to ineligible rollovers, must be removed from the IRA by the IRA owner’s tax filing deadline, including extensions. Individuals who file their return or taxi fling extension by April 15 (April 17 for this year), receive a 6-months automatic extension to correct the excess – i.e. to October 15.

Therefore, if the rollover occurred last year, he has until October 15 of this year to remove the excess amounts along with any earnings. The excess amount is not taxable and is not included in his earnings. Any earnings would be taxable.

He will receive another 1099-R amount for the return-of-excess from the IRA. But if the amount if removed timely, and processed properly, the 1099-R should reflect only any earnings as taxable.

Earnings are computed using the formula in TD9056, available at http://www.irs.gov/pub/irs-regs/td9056.pdf

Some custodians will compute the earnings.

Appleby: It's the clause in your third paragraph -- "and processed properly" -- that worries me. Can you be more specific?

Sure,

In order for the amount to be a true ‘return-of-excess’, the Net Income Attributable (NIA) must accompany the excess contribution that is removed on a timely basis.

The key is to ensure that the instructions submitted to the financial institution clearly show that the transaction is a ‘return of excess contribution’ and not a regular distribution. Unfortunately, this is a mistake that is often made when completing the forms, resulting in no earnings/losses being removed with the excess and the amount being reported as a regular taxable distribution.

Even if the proper instructions are submitted to the financial institution, someone should follow-up to make sure it is processed correctly- as mistakes are sometimes made by financial institutions.

In short:
----The correct amount should be removed
----If the amount is removed by the deadline, the NIA must be included. The instruction to the financial institution should distinguish the excess amount and the NIA, unless the financial institution calculates the amount
----If the amount is removed timely, and processed properly, the taxable amount in box 2a should reflect only earnings


Note: Since the NIA could be a loss, it is possible that the amount received from the IRA for the transaction is less than the amount contributed to the IRA. If that situation arises, the IRA owner may want to include a letter with the check, and a copy of the calculation, to show how the amount was determined.

Please post any follow-up questions.
Denise