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"failed" direct rollover - obligations of plan?


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Per a member's/distributee's request, a plan prepared a direct rollover check made payable to the eligible retirement plan, gave check to the distributee/plan member for delivery to the payee. The plan member somehow managed to cash the check, even though was not made out to him.

Plan, of course, did not withhold mandatory 20% because it was a direct rollover. Distributee now comes back to plan and asks for a "corrected 1099" showing distribution as ? not sure what, but something other than a direct rollover.

Questions: (1) should the plan correct the 1099R, since the one it issued was presumably correct base on available information? It had no control over the member's ability to improperly cash the check made out to the rollover plan.

(2) if no corrected 1099R should be issued, does the plan have other reporting reuqirements relating to this set of facts, or is this solely a problem now for the member/distributee?

(3) I do not believe the plan should be liable for failing to withhold, under 3405 regs, but can anyone offer additional comfort (cases, PLRs) for me/my client? Q7 of 31.3405©-1 does not contemplate this bizarre set of facts.

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Does the Plan have to do anything? Whose problem is it?

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Does the Plan have to do anything? Whose problem is it?

Ordinarily I would think no the plan does not have to do anything, but for the fact that the plan now has actual notice of what occurred because the distributee contacted us. Does this make it our problem now? I don't know. (Thus, the post!)

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It [the Plan] had no control over the member's ability to improperly cash the check made out to the rollover plan.

I assume that the check was properly made out and therefore agree that it is not the Plan's fault. Sounds like the distributee should have followed the age-old advice of consulting a tax or financial advisor before "taking" a distribution from the Plan.

Let the distributee and whoever cashed the check try to explain to the IRS what's wrong with the 1099 that the Plan issued.

As a suggestion for future reference, mail the check to the receiving plan.

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My 2 cents:

It sounds like the participant wants to report it correctly & I believe that is the IRS's main concern as well. They want to be sure that the taxes (and/or 10% excise) are paid. I think as long as the participant reports it correctly on his personal return, that should take care of it. You don't file the 1099-R with your return unless taxes were withheld which, in this case, they were not.

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It sounds like the participant wants to report it correctly & I believe that is the IRS's main concern as well.

I agree. I might be willing to issue a corrected 1099, but the payee could take the position that they accurately reported what they did, and what happened afterward is out of its control and there's no need to do a correction. And if the participant reports it as income, that's what matters.

Ed Snyder

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the IRS's main concern

If the point is whether or not the distributee pays his taxes, then issue the corrected 1099. How else is the IRS to know that the distribution is taxable?

If this guy thinks it's OK to cash a check that is made payable to a rollover receiving account, what's to stop him from using the uncorrected 1099 as evidence of a taxable amount of zero when he does his taxes next year, his integrity?

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I don't have a cite, but the IRS recently ruled that if the check is made payable to the rollover institution, delivered to the distributee, but not turned over by the distributee to the rollover institution until more than 60 days and then does so, it is nonetheless a proper DIRECT rollover. The IRS explained that the distributee did not have control over the funds because the check was made payable to the rollover institution. So I don't think it is the plan's duty to send the check directly to the rollover institution. Implicit in that ruling is that delivering such a check to the distributee is acceptable.

I would simply r1099-R it as a direct rollover, and leave it as that. From the plan's perspective that is exactly what happened. Effectively for the distributee, it is not much different than if he delivered the check, it was deposited into an IRA for him, and then he withdrew it promptly after that. If the distributee had robbed the bank and took only the amount of the distribution right after it had been deposited in the bank, would you feel the need to tax report it differently if you learned of the robbery? Here the crime against the bank is forgery, not robbery. But either way, it does not involve the plan (the drawee bank might have stand the loss to the forgery victim (here, who knows who that would be) under the law of negotiable instruments).

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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I changed my mind. I don't know what the correct approach should be. Now that the Plan has knowledge, should it take steps to prevent the check from being honored? What if it already has been honored? Any banking/UCC experts out there? What are the Plan Administrator's fiduciary responsibilities here if it actually sees a copy of the negotiated check and has proof that it was forged? Interesting question.

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I changed my mind. I don't know what the correct approach should be. Now that the Plan has knowledge, should it take steps to prevent the check from being honored? What if it already has been honored? Any banking/UCC experts out there? What are the Plan Administrator's fiduciary responsibilities here if it actually sees a copy of the negotiated check and has proof that it was forged? Interesting question.

Per the OP, the check has already been cashed "somehow" by the distributee. Arguably if the IRS is unable to get at least 20% collected from the distributee, the IRS would be considered the forgery victim (the IRS being the third party beneficiary of the mandatory tax withholding requirement). If the IRS could establish that, then the drawee bank (the one that allowed the check to be erroneously negotiated) would have to pay that 20% to the IRS under banking/UCC rules. Whether the plan has a duty under federal and/or state criminal laws to report the crime, if in fact forged, I would have no idea.

Interestingly, the OP explains that the distributee is asking the plan to change the f1099-R that issued reporting it as a direct rollover. I would not change it. I would let the employee simply report the amount of the check as taxable income. I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

Not disagreeing w/ your comments, is it possible that other taxpayers have a dog in this fight? If the EE uses the existing 1099 as proof that there is no taxable income, then he may have gotten (from his perspective) a "tax-free distribution".

Thoughts?

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

Not disagreeing w/ your comments, is it possible that other taxpayers have a dog in this fight? If the EE uses the existing 1099 as proof that there is no taxable income, then he may have gotten (from his perspective) a "tax-free distribution".

Thoughts?

Other taxpayers are affected, no doubt. But courts have repeatedly held only the IRS has standing to pursue the matter in courts.

I guess the point being, the plan took all steps expected by the IRS of the plan. It reported the transaction accordingly. The distributee has a tax obligation because the distributee changed his/her mind and did not deposit the check into the IRA, instead somehow cashing it. I see it is the IRS's role, not the ER's to enforce the resulting tax obligation from the taxpayer's actions. The distributee's election cause the ER to not withhold 20%, and to report the payout as a direct rollover. At the time of both, the ER had no reason to know differently. It acted appropriately. There are a couple of Tax Court cases that hold if the original return was filed on a good faith belief in the facts that later are discovered wrong, the taxpayer is not obligated to file an amended return. I just don't see how it is the plan's issue upon learning later what the taxpayer did. It's now an issue directly between the taxpayer and the IRS.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Isn't the rollover receiving plan also a forgery victim here? Someone (a bank, mutual fund, etc.) would have been making more money if the deposit to the receiving plan had been properly made. I wonder if the receiving plan ever asked what happened to the money they were supposed to get, but that is not the issuing plan's concern.

Thanks, JSimmons, for the explanation that the plan does not have to issue a revised 1099. Apparently, the only reason to do so would be to honor Mr. Devious' request for a revised 1099, which would inform the IRS that he owes taxes on the distribution he took. But the revised 1099 would show no withholding, so maybe the plan should also attach a note to the IRS explaining why it did not withhold. Hmmm, that works for me.

I'm having trouble with knowingly letting him off tax-free as being a prudent act.

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Isn't the rollover receiving plan also a forgery victim here? Someone (a bank, mutual fund, etc.) would have been making more money if the deposit to the receiving plan had been properly made. I wonder if the receiving plan ever asked what happened to the money they were supposed to get, but that is not the issuing plan's concern.
Yeah, but no corresponding benefits obligation either. So kind of a wash, except for the investment adviser who would have had more asset-based fees, I suppose. Not the most sympathetic victim for a court to hinge a ruling off of.
Thanks, JSimmons, for the explanation that the plan does not have to issue a revised 1099. Apparently, the only reason to do so would be to honor Mr. Devious' request for a revised 1099, which would inform the IRS that he owes taxes on the distribution he took. But the revised 1099 would show no withholding, so maybe the plan should also attach a note to the IRS explaining why it did not withhold. Hmmm, that works for me.
Read: problems dealing with IRS mailings for months, asking for the 20% from the plan that was supposed to be withheld if you report it as a lump sum payout.
I'm having trouble with knowingly letting him off tax-free as being a prudent act.
The lack of a changed f1099-R does not prevent the distributee from properly declaring the distribution as taxable income. It does not get him/her off the hook and entitled to a tax-free distribution. It's self-assessment, or IRS assessment if audited. In fact, given the fact that the distributee has so approached the plan now and explained what he or she has, it might be tax fraud for the distributee not to report it as taxable income. That's separate and apart from the fact of the f1099-R, which is the issue for the payor plan.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Thanks, John. You've clarified it for me (once again).

I admit to being one of Mr. Rigby's other taxpayers, upset that this crook is likely to pull off his tax free distribution scheme.

Of course, it's springtime, from which blossoms the hope that he will do the right thing. 'Past performance is no guarantee of future results' works both ways.

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The IRS actually matches the 1099-R rollover with a 5498. When the match fails there will be an audit of the plan, requests for front and back of ALL checks for that year - an imposition on both the TPA and the client. I would fix the 1099-R and only if questioned on the withholding issue disclose what happened. If you do electronic filing of the 1099-R, it can be fixed now. If paper filing must be a corrected 1099-R.

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The IRS actually matches the 1099-R rollover with a 5498. When the match fails there will be an audit of the plan, requests for front and back of ALL checks for that year - an imposition on both the TPA and the client. I would fix the 1099-R and only if questioned on the withholding issue disclose what happened. If you do electronic filing of the 1099-R, it can be fixed now. If paper filing must be a corrected 1099-R.

Is a 5498 filing required only for IRA's, or for any receipts of an eligible rollover distribution? (From the form, looks like only for IRA's.) I need to get more facts from my client as to the intended recipient of the direct rollover.

My concern with "fixing" the 1099-R is that it may suggest that it was improperly reported in the first place. I do not want to subject them to penalty assessments for improper reporting, even though they have very good reasons for arguing that no penalty should apply.

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msimpson - I recommend that you consider JSimmons' comments very carefully.

Since the issuing plan did things correctly and is under no obligation to issue a revised 1099, it shouldn't. The plan does not need to become a party to Mr. Devious' web of deceit.

Furthermore, if the plan were to issue a revised 1099, then the plan, not the crook, will receive the on-going requests from the IRS for the withholding (ref. post #17, above), which would be an unwelcome and avoidable penalty on the plan.

Of course, the plan may wish to confirm all this with its own attorney.

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I'll take a seat on the fix the 1099 side of the table.

There are a couple of Tax Court cases that hold if the original return was filed on a good faith belief in the facts that later are discovered wrong, the taxpayer is not obligated to file an amended return.

Would that apply if the filing instructions say that you must file a corrected form? The general 1099 instructions, section H, page 6 says

If you filed a return with the IRS and later discover you made an error on it, you must:

• Correct it as soon as possible and file Copy A and Form 1096 with your Internal Revenue Service Center (see part D on page 5).

Has anyone actually had the IRS come back after the plan for 20% withholding that wasn't done?

How would the IRS know from the corrected 1099-R that it wasn't a hardship distribution where 20% mandatory withholding would not apply?

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If you filed a return with the IRS and later discover you made an error on it, you must:

• Correct it as soon as possible and file Copy A and Form 1096 with your Internal Revenue Service Center (see part D on page 5).

Plan did not make an error, participant made first error and bank honoring the check made second error. It is not the plan's responsibility to correct other party's errors. It would be a third error for the plan to issue a 1099-R that did not reflect what the plan actually did, which was to pay a distribution in the form of a direct rollover.

I'm addicted to placebos. I could quit, but it wouldn't matter.

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FWIW, I come down on the side of those who believe the plan has no responsibility to "correct" anything. Plan reported it correctly.

As an aside, not that it matters in the least, but it doesn't appear that this participant is trying to avoid paying taxes. In the original post, the participant is asking that a 1099 showing a rollover actually be corrected to reflect something else, which presumably would be a taxable distribution.

"Distributee now comes back to plan and asks for a "corrected 1099" showing distribution as ? not sure what, but something other than a direct rollover."

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