Jump to content

Rollover later determined to be ineligible


Guest sheTexasHammer

Recommended Posts

Guest sheTexasHammer

Plan B accepted rollovers from Plan A, thinking they were eligible for rollover treatment, and then later found out that a portion of the rollover distribution was NOT eligible for rollover treatment. Plan B must distribute the ineligible rollover amount back to the employee. My question is whether Plan B would be required to withhold under Code Section 3405 when it distributes the portion of the rollover that was ineligible? I think that because this is a distribution of an amount that shouldn't have gone into the plan to begin with that there is no withholding obligation on part of Plan B, is this correct?

The reason I ask is that Plan A is trying to recoup a mistaken employer contribution in the Plan, in which some participants took distributions of their accounts and rolled them over into Plan B. If Plan B withholds, the employee will not have enough cash on hand to return the funds to Plan A that he was not entitled to to begin with.

Link to comment
Share on other sites

Plan B accepted rollovers from Plan A, thinking they were eligible for rollover treatment, and then later found out that a portion of the rollover distribution was NOT eligible for rollover treatment. Plan B must distribute the ineligible rollover amount back to the employee. My question is whether Plan B would be required to withhold under Code Section 3405 when it distributes the portion of the rollover that was ineligible? I think that because this is a distribution of an amount that shouldn't have gone into the plan to begin with that there is no withholding obligation on part of Plan B, is this correct?

The reason I ask is that Plan A is trying to recoup a mistaken employer contribution in the Plan, in which some participants took distributions of their accounts and rolled them over into Plan B. If Plan B withholds, the employee will not have enough cash on hand to return the funds to Plan A that he was not entitled to to begin with.

If it wasn't eligible for rollover, then Plan B should send the money back to Plan A and let them deal with it.

William C. Presson, ERPA, QPA, QKA
bill.presson@gmail.com
C 205.994.4070

 

Link to comment
Share on other sites

Guest sheTexasHammer

The Internal Revenue Code Regulations specifically say that a rollover that was accepted by a Plan and later realized to be ineligible must be distributed to the employee (not back to the original plan).

My question is whether upon this distribution, the accepting Plan would be liable for any withholding? I think the answer is no generally, and I think the answer is also no in light of the fact that the ineligible amounts represented an improper employer contribution in the first place (not taxable to the employee because the employee has to return it).

Link to comment
Share on other sites

Guest sheTexasHammer

No worries. I was just hoping someone might know the answer to this question, but I don't think there is one! I've looked for hours.

Link to comment
Share on other sites

Guest Sieve

You are correct that a plan is not penalized for accepting an invalid rollover if, among other things, distribution is made to the employee within a reasonable time. (Treas. Reg. Section 1.401(a)(31)-1, Q&A-14(a).) But, why wouldn't it then be subject to withholding if it is, in fact, a distribution from the receving plan (Plan B)? What exception to withholding, taxation, or potential early distribution excise tax would it meet?

I don't see how it's an improper employer contribution as far as Plan B is concerned, since the $$ did not come from the employer B. Rather, it's an invalid rollover, and its invalidity causes the employee to have received income as a result--and, I would think, all the luggage that comes with the distribution (although the reporting and withholding is not kicked back to Plan A, but is the obligation of the receving/distributing plan, i.e. Plan B).

The withholding should not be the mandatory 20% under IRC Section 3405© because it no longer is an eligible rollover distribution, so it should be subject to waivable 10% withholding under IRC Secton 3405(b).

Whether or not the individual can pay back all that was improperly allocated by Employer A out of the distribution from the Plan B, without digging into non-plan assets, is a personal problem, not a plan or withholidng problem.

Link to comment
Share on other sites

Guest sheTexasHammer

Your response was exactly what I was afraid of......

I can't find a definition/description of "distribution" for purposes of Section 3405 that deals with this specific situation.

Link to comment
Share on other sites

Guest Sieve

And, if you can't find a specific definition covering this situation or if there is no exception to the general rule, then the general rule has to apply. I find no exception in 3405 or the 1099-R Instructions.

But it certainly should be no surprise that that's the result. Why would the rules permit a tax-free "defective" rollover to result in an eventual distribution to the employee without the necessity to withhold?

But, as I said, I believe the withholding can be waived by the employee. Still, the onus for carrying out the withholding rules falls on the plan which received the defective rollover.

Link to comment
Share on other sites

  • 10 months later...

I've run into a similar problem, and I have a question about taxation to the participant. Specifically, is there anywhere in the Code or regs that the participant could look to to establish basis in the distribution from Plan B? What I mean is, suppose Plan A does a corrected Form 1099-R indicating that amounts the individual had previously received were not eligible for tax free rollover. So, the individual must pay tax on that amount. How, then, can the individual establish basis in the distribution from Plan B? He shouldn't have to pay tax on the same amount twice, but I can't find a code section or regulation that would give the individual a basis.

Link to comment
Share on other sites

  • 3 years later...

1. If the "defective" rollover is paid back to the original plan (in the example, Plan A) by the employee, does the employee have taxable income? It would seem that the employee should not have taxable income because he is not keeping the distributed amount; rather, the distribution (or part thereof) that was not an eligible distribution is being distributed by Plan B to the employee and then the employee is repaying this amount to the plan. I know that the employee can waive out of he 10% withholding; but I'd like to figure out the proper tax treatment to the employee. Assume all transactions occured within the same year (plan and calander year).

2. Should Plab B issue a 1099-R for the corrective distribution?

3. Would the result differ if Plan A made the defective rollover distribution to an IRA (rather than another 401(a) qualified plan)?

Thanks!

Link to comment
Share on other sites

1. If the "defective" rollover is paid back to the original plan (in the example, Plan A) by the employee, does the employee have taxable income? It would seem that the employee should not have taxable income because he is not keeping the distributed amount; rather, the distribution (or part thereof) that was not an eligible distribution is being distributed by Plan B to the employee and then the employee is repaying this amount to the plan. I know that the employee can waive out of he 10% withholding; but I'd like to figure out the proper tax treatment to the employee. Assume all transactions occured within the same year (plan and calander year).

2. Should Plab B issue a 1099-R for the corrective distribution?

3. Would the result differ if Plan A made the defective rollover distribution to an IRA (rather than another 401(a) qualified plan)?

Thanks!

I would treat the rollover back to Plan A as a non taxable rollover. If it is treated as taxable income how can it be rolled back to the plan? As far as Plan B is concerned the amount returned is part of a rollover distribution from Plan A. Since plan A made the mistake of distributing an incorrect amount the employee should be held harmless.

Plan B should file a 1099 for a rollover back to plan A since Plan B is treating the returned amount as pre tax rollover.

I don't see any reason for different treatment if the returned amount comes from an IRA.

mjb

Link to comment
Share on other sites

  • 1 year later...

I wanted to follow up on JWB19's post / question as I have a similar question.

In my case, an executive rolled his entire account balance from Old Plan to New Plan in early 2014. After rolling over, Old Plan determined that it failed testing in 2013 and executive had excess contribution. Old Plan issued 2 1099s to executive for 2014--one for the excess contribution amount reflecting it as taxable distribution and the second for the remaining portion of the rollover amount. Executive informed New Plan that excess portion was an ineligible rollover and had been reported as taxable distribution. New Plan said it would transfer excess portion back to Old Plan "f/b/o participant" and report on 1099 as a nontaxable rollover distribution. However, Old Plan has since been terminated and all assets distributed. Old Plan recordkeeper has advised that it cannot except the excess contributions back since plan has been terminated. Old Plan says New Plan should distribute to employee. New Plan says if it does that, it will have to report distribution as taxable distribution.

I can certainly understand the position of both plans / recordkeepers here but it seems this leaves executive with potentially getting double-taxed on the excess contribution or, at best, left with a mess trying to explain to the IRS why this should not be the case.

JWB19, if you are still out there, did you find an answer / solution to your situation?

Would be most appreciative for any thoughts / experience anyone has with similar issues.

Link to comment
Share on other sites

What evidence did Plan B's administrator evaluate to support its decision that an amount paid to Plan B was not a proper rollover contribution?

Did Plan B's administrator afford Plan B's participant an opportunity to submit any evidence he or she might choose to submit to show that the amount paid to Plan B was a proper rollover contribution?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

Link to comment
Share on other sites

Thanks. I'm not sure I understand the questions exactly but will try to respond. The New Plan has been presented copies of the ADP testing results for the Old Plan and Old Plan's 1099-Rs issued to participant, including the separate 1099-R issued to the participant for the excess amount. While the New Plan did not re-run the testing or really put the screws to the Old Plan's determination of the excess amount, I don't think any party involved (including the participant) really questions that there was an ADP failure and thus the general conclusion that the excess amount was an ineligible rollover. Does that help? Are you thinking there might be some basis for the New Plan to retain the amounts if the evidence of invalid rollover is not that strong? I think the New Plan is fairly well convinced of the need to kick the amounts out--it would just like to do so in a way that doesn't put the paricipant in a bind.

Link to comment
Share on other sites

I suggested the questions because I've seen situations in which an employer suffered liability for making a too-hasty decision to treat an amount as not a proper rollover contribution, unfairly depriving its participant of the plan's opportunity to accumulate tax-deferred retirement savings.

A disappointed participant might claim, sometimes successfully, that the receiving plan's administrator lacked sufficient evidence to support its finding. It might be easier to defend against such a claim if the administrator even-handedly afforded the participant an opportunity to furnish evidence that could have helped the administrator more thoroughly and carefully consider its decision.

That said, the situation described might not involve these concerns.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

Link to comment
Share on other sites

  • 4 years later...

Okay, I have a slightly different issue.  I had a 401K plan from April  2017 to November 2017. I left the company in November 2017 and rolled the 401K into a IRA in December of 2017.  In March of 2018, I was informed the 401K plan failed the ADP plan and I had to have the Excess contribution and Earnings returned to me so the 401K plan could say it was now Okay to the IRS.  My IRA company did return the funds to me and withheld a small amount for tax withholding that they sent to the IRS.  Now my IRA company is trying issue the required 1099R to reflect this (the 401K plan can't do it).  Even though I explained it all to IRA company  at the time of withdrawal and again in 2019 when I disagreed with the 1099R they issued, they are saying the 1099R they issued is correct. I talked to the IRS on phone and they agreed with me.  The Excess contribution was in a 401K plan and should be regulated as such.  Publication 525 makes it very clear (in my opinion) that the "Excess contribution" ,Plus earnings on excess contribution through end of 2017 should be taxed as wages in the year the funds were distributed to me, not the year they were contributed..  So the Total and taxable distribution should be the same, and should be taxable in year 2018 (Code 8), and not marked as an IRA since the funds and excess were really from a 401K not and IRA (this allows the tax software to put in wages and not IRA distribution).   The IRA company thinks the 1099R should show total distribution as what they removed, the taxable amount as only the calculated earnings, and as taxable in 2017 (Code P)  and that it is an IRA distribution.  While I sort of understand their position it came from IRA which it did from their account,  I believe in this case they should be treating this simply as the IRA company  being the agent for the 401K to return the funds since the 401K no longer has the funds to return to me.   While I believe if I follow the 1099R as they issued it, I would pay less taxes, I don't think that is correct by IRS regulations and the facts in this case.  If I file based on their current 1099R I could be liable for filling a false return.  If I can't get them to change their 1099R, and I put it into my Tax Software as needed, I will trigger and audit because that does not match the IRA company filing, even though they are wrong.   This is a rather unusual case of rolling over a 401K  to an IRA before the Excess contributions  caused by an ADP test failure issue has been resolved.  I'm hoping someone out there has an opinion or experience with something like this.  Any HELP!

Link to comment
Share on other sites

Well, it's a little hard to follow but I don't think the IRA custodian has a choice here.  They can't just change their reporting to act as if they were the 401(k) plan.  What happened is that you rolled over your full account in 2017, and later it was determined that some of that was not eligible for rollover, so the IRA disgorged it in 2018, but doing so treats it as an "excess contribution" for 2017.  (Essentially the same as if you contributed more than the $5000 limit as a regular IRA contribution...you don't get a deduction for the excess and they return it as a non-taxable distribution, except for earnings.)  I think their reporting is accurate.

But, in this case, your 401(k) plan should have issued two 1099-Rs (for 2017), one showing a rollover for the total minus the test failure, and another showing the test failure amount as taxable since it can't be rolled over.  So processing the distribution in 2017 instead of 2018 (should have) unwittingly and inadvertently caused the failure amount to be taxed in 2017 instead of 2018.  Somehow I get the feeling the 401(k) just gave you one 1099-R, for the full amount rolled over?  I think that is the crux of the issue here.

I'm not saying it's right but I think if you just file based on the 1099s you got you won't get any static.  If you do the right thing and claim the income in 2017 (yes I meant 2017), you'll probably get an inquiry of some sort because while you can get away with a lot concerning things they don't know about, if there is a mismatch on forms they receive (e.g. 1099s) vs. what you report on your 1040, they will look into it (even to say you paid too much).

I haven't seen this so I'm just throwing stuff out there for conversation...maybe someone else has direct experience and can share.

Ed Snyder

Link to comment
Share on other sites

  • 1 year later...

Related issue.   Curious as to how to document this properly for the IRS:

1. In 2017, I close a 401K account with Plan A and do a direct (trustee to trustee rollover) to 401K Plan B

2. In 2020, receive letter from Plan A that Plan A employer miscalculated vesting and an thus a portion of the rollover was ineligible.   This was an employer contribution that was improperly vested.

     a. Plan A directed me to withdraw the amount of the overpayment + applicable earnings from Plan B

     b. Plan A directed me to return the overpayment amount + applicable earnings

3. Plan B cuts me a check for the overpayment + applicable earnings - claims it cannot cut a check directly to Plan A

4. Plan A has issued revised 1099Rs for TY2017 - one for the correct rollover amount with code G and one for the overpayment (incorrect vesting) with Code E

Questions:

A. Is there any reason I should NOT deposit the check from Plan B and issue a cashier's check to Plan A to return the overpayment + earnings?  Should Plan B have cut a check directly to Plan A?

B. Will I have an IRS liability in 2017 or 2020 if I return the money to Plan A? 

C. How do I document this so it is clear to the IRS?

Link to comment
Share on other sites

Did you request the money from Plan B as an excess contribution?  You need to find out what code they (Plan B) will report this under.

I'm honestly not quite sure how Code E works, but I can tell you that if Plan B intends to report using Code 1 or Code 7 (an early or normal distribution), that it is taxable, and it should not be (since the rollover was effectively disallowed, making it taxable going in).  

Ed Snyder

Link to comment
Share on other sites

More info from another thread pasted here for clarity, or perhaps confusion.

__________________________________________________________________________________

Seems I have a similar situation.   Will I owe taxes on the excess distribution described below even if it was never my money?   Seems unfair.

1.     In April of 2017, I initiated a plan-to-plan rollover of 401K funds from a former employer,  which were being held at Prudential Retirements to the 401K plan of my current employer,  which are held at Merrill Lynch.

2.     The amount of funds transferred directly from Prudential to Merrill was $37,969.60

3.     I received confirmation from Prudential that the funds were directly transferred and validated that they were deposited in my 401K account at Merrill.

4.     I received a letter from Prudential dated July 31, 2020, that Vodafone made a determination that Vodafone improperly stated my vested interest in the account.   As a result, an overpayment of $7,391.14 was rolled over directly to Merrill.

5.     Vodafone has requested that Prudential request that I withdraw the funds and related earnings and return them to Prudential.

6.     Prudential has already produced revised 1099R forms to reflect the correct rollover eligible for tax deferral and the portion that is in excess.   One 1099R is coded "G" the other as "E".    

7. My tax preparation software tells me I have to pay taxes on the amount coded "E".    

Ed Snyder

Link to comment
Share on other sites

  • 7 months later...

Good afternoon,

I have a similar question, a client had a SIMPLE plan with himself and just one other employee as participants which was opened in 2018 with Recordkeeper X.  in 2019, he decided to move the SIMPLE to Recordkeeper Y so he told Recordkeeper Y to set up a new SIMPLE that would be ready to receive the rollovers.  Howe/er, the client already had a SEP account with Recordkeeper Y.  As you guessed, Recordkeeper Y placed the SIMPLE rollovers from Recordkeeper X into the SEP account instead of a newly established SIMPLE account (this being in 2019, its less than the 2 year rollover limit).  The client only just found out about this issue now as he trusted Recordkeeper Y was doing things correctly and has been maxing out his contributions to the SEP (supposed to be SIMPLE) for 2020.  I understand that the IRA holders can request a rollover back into a new SIMPLE account (which Recordkeeper Y should pay earnings on) and self-certify as to the mistake to avoid any penalties but what about the status of his original SEP and current/former SIMPLE plans; is this a significant operational failure?  Does he as owner have any duty under EPCRS/VCP to correct the failures or should he just get a letter from Recordkeeper Y that they messed up acknowledging liability and keep it on record in case of audit?

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
×
×
  • Create New...