Jump to content

Correction of SIMPLE IRA ee deferral


Guest amfam2
 Share

Recommended Posts

Guest amfam2

I have a client who is a sole proprietor and employs his wife. They also have 9 employees.

They made a SIMPLE IRA contribution for wife, but end of year accounting records show that wife did not receive wages or compensation from employer. They closed SIMPLE IRA account after noticing mistake. The 1099R shows a premature distribution from SIMPLE IRA subject to 25% penalty.

Client called and asked us to "fix" this... they contend the contribution was not based upon compensation, thus the SIMPLE IRA was not valid. Therefore we should treat the distribution as a closing of account/ mistake of fact and not a premature distribution from a SIMPLE IRA.

I am interested in your thoughts on these points:

1) The distribution was correctly reported on 1099r. Perhaps the client can utilize Form 5329 to explain why they are not subject to the 25% penalty (my guess is that they would have to apply FICA w/h in this correction).

2) Can they self correct under EPCRS? Or should they apply for ruling from IRS as to correction?

Link to comment
Share on other sites

The excess should be included on Form W-2 box 1 (but not included in box 12). Arguably, this is sufficient to eliminate the 10 percent penalty on nondeductible employer contributions.

The bank shd be shown a letter of explanation on employer letterhead (not required, but helpful) stating what happened and that the amount ($___) WILL BE included on ____'s W-2 box 1 (wages) for 2003.

The individual's letter (enclosing the above) sd request that the amount be recoded on Form 1099-R) as an "excess contribution returned before the due date." [Any distribution of gain may be taxable and subject to the 10 percent tax if under age 59-1/2 unless an exception applies.] Arguably, neither the 10 percent or 25 percent penalty applies to the return of the excess even if under age 59-1/2 if it is treated as such). You might want to add what the IRS has said (see following example).

Example. An employer established a SIMPLE for 2003. On June 8, 2003, the employer adopted a qualified profit sharing plan and made contributions to such plan for 2002. According to informal guidance, corrective distributions would not be subject to the 25 percent penalty. [ASPA National Conference, 2000, IRS Q No. 376] On September 25, 2000, in Arlington, Virginia, representatives of the ASPA (American Society of Pension Actuaries) met with three senior IRS employees: James E. Holland, Jr., Chief, Actuarial Branch I; Paul Shultz, Director of Employee Plans, Rulings and Agreements; and Richard J. Wickersham, Chief, Projects, Branch 2. The IRS representatives stated that the 25 percent penalty would not apply when an employer adopted a 401(k) plan invalidating the qualified salary reduction plan a SIMPLE. The meeting served as the basis for discussions at the ASPA National Conference. Although accurate, the statements do not represent official positions of the IRS, nor were they reviewed or approved by the IRS or the Treasury Department.

I see no reason, why the above would not apply to an excess contribution. The 25% penalty (see above) sd not apply. The 10 percent penalty sd not apply to the distribution of the excess because the amount is nontaxable (if it was also included on Form W-2 issued by the employer).

WITHOUT SOME FORM OF EXPLANATION THE TRUSTEE/CUSTODIAN HAS NO CHOICE BUT TO CODE IT AS SUBJECT TO A 25% PENALTY. IF THE EXPLANATION DOESN'T WORK, then file Form 5329, show $0, and provide an explanation and supporting materials as to why the penalties do not apply. But it must have been reported on the W-2 for this to work properly. See From 5329, fill in item on line 2 of Part 1.

Arguably, if the amount was left in (had it not been withdrawn ever) it would be subject to tax again when distributed [to extent it exceeded the allowable correction amount under IRC 408(d)(5)] even if included on Form W-2, but the 6 percent tax does not appear to be a problem either way. It could be removed in smaller increments and possibly escape double taxation.

The employer wd have a problem if excess not included on Form W-2. I'm not sure what would happen if excess is properly removed and amount was not included on Form W-2. If amount removed, then maybe employer does not have major problem, but may cause the individual a double taxation issue at some point.

I expect some disagreement here, but may not be able to respond for a few days. :ph34r: Before you do, however, see instructions on back of Form W-2 for completing box 12.

Furthermore, and notwithsatanting all of the above, the SIMPLE IRA excess contribution and correction rules are not clearly set forth by the Code or in IRS guidance. So, there you have it - my opinion. Fire away....

Link to comment
Share on other sites

  • 7 months later...
Guest Peter Buck

If a sole proprietor did the same thing - put $ into a Simple before realizing he would have no income, could the same strategy be used - letter to the broker with explanation, and instead of showing the $ added back into the W-2, a statement by the accountant that the deduction was never taken for the incorrect contribution? Would that be in effect the same thing?

Link to comment
Share on other sites

Guest Peter Buck

And does the IRA have to be closed for this to work - can he request a distribution of the amount contributed in error? Seems like he should

Link to comment
Share on other sites

You are correct, the self-empoyed just don't deduct the excess (the correction). Sure, the excess needs to be corrected--to avoid double taxation. If properly documented, the trustee can report this as a return of an excess amount, and not subject to the 25% penalty. Distributed gain, if any, will be subject to the 10 percent penalty, unless an exception applies. What you need is trustee/custodian cooperation.

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...