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402(g) Limit - Corrected After April 15


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Let's say a participant contributed over the 402(g) limit in 2017 to the plan and the error wasn't discovered until after April 15? How would this issue be corrected?

 

My understanding is that if the participant exceeded the limit at just one company, that means that the plan is at risk of disqualification and the excess needs to be distributed even if the participant is not terminated. Is that correct? Also, I read that the 10% penalty would apply as well as the 20% Federal tax rate. How would that be coded? Still code "8"?

 

Thanks.

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You are correct that if excess is in one plan than it must be distributed.  Post 4/15 results in double taxation - reported on 1099-R as excess deferral in 2017 - code P I believe with whatever other applicable Code (Code 1, 7, etc.) and 2018 (assuming it is distributed this year) for the year of the actual corrected distribution (excess deferral plus earnings) - code 8 with whatever other applicable Code.  There may be a 10% penalty depending on the age of the participant.  There would not be 20% mandatory withholding because the amount is not eligible to be rolled over.

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to add to Madison's comments:

my mental anguish is that the distribution takes place in 2018, so it is the 2018 1099R form that is used, but you don't see that until next year, it is simply the person still reports the excess deferral in 2017 even if it was refunded timely! but you have no 1099r yet to indicate it at the time you file the taxes. or at least that is how I understand it works.

 

and yes early withdrawal applies, here is the IRS example

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-elective-deferrals-exceeded-code-402g-limits-for-the-calendar-year-and-excesses-were-not-distributed

 

IRC Section 72(t) imposes a 10% additional tax for distributions that don't meet an exception, such as death, disability or attainment of age 59 ½, among others. To avoid this additional tax, correct excess deferrals no later than April 15 of the following year. If you don't correct by April 15, you may still correct this mistake under EPCRS; however, it won’t relieve any Section 72(t) tax resulting from the mistake.

Under Revenue Procedure 2016-51, Appendix A, section .04, the permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable both in the year of deferral and in the year distributed. These amounts are reported on Forms 1099-R. In the case of amounts designated as Roth contributions, the excess deferral will already have been reported in income in the year of deferral. However, the amount will be reported as taxable in the year distributed.

Example:
Employer X maintains a 401(k) plan that has 21 participants and plan assets of $715,000. For calendar year 2017, Ann deferred $18,500 to the plan. None of the elective deferrals were designated as Roth contributions. Ann is under age 50 and isn't eligible to make catch-up contributions. Ann has excess deferrals of $500 because $18,000 is the 402(g) maximum amount permitted for 2017. Employer X didn't discover this mistake until after April 15, 2018. On November 1, 2018, X distributed the excess deferral (plus earnings of $10, totaling $510) to Ann.

For 2017 (year of deferral), Ann must include $500 in gross income. For 2018 (year of distribution), Ann must include $510 in gross income. Employer X would report this amount on Form 1099-R. In addition, Ann must pay the additional 10% early distribution tax under IRC Section 72(t).

and note from the 1099 instruction for 2018, the far right column indicates other codes that can be used (1 = early withdrawal)

8—Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2018.

Use Code 8 for an IRA distribution under section 408(d)(4), unless Code P applies. Also use this code for corrective distributions of excess deferrals, excess contributions, and excess aggregate contributions, unless Code P applies. See Corrective Distributions, earlier, and IRA Revocation or Account Closure, earlier, for more information.

1, 2, 4, B, J, or K

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21 hours ago, Tom Poje said:

my mental anguish is that the distribution takes place in 2018, so it is the 2018 1099R form that is used, but you don't see that until next year, it is simply the person still reports the excess deferral in 2017 even if it was refunded timely! but you have no 1099r yet to indicate it at the time you file the taxes. or at least that is how I understand it works.

The anguish should be minimal if done correctly

Lets say that the EE (not catch-up eligible) deferred $20,000 in 2017, resulting in excess deferrals of $2,000.  The W-2 should reflect $20,000 deferrals but only reduce income by $18,000.  No 1099-R is needed to let the participant know to include it in income since the W-2 (should have) already included the $2,000 excess in as income in 2017.  

In 2018, the plan distributes the $2,000 excess plus earnings on the excess, lets use $200 for earnings.

The plan issues two 1099-Rs for 2018

  1. 1099-R for $2,000 with code P (taxable in the deferral year)
  2. 1099-R for $200 with code 8  (taxable in current/distribution year)

The W-2 signaled to the IRS that there was an excess of $2,000 and the 1099-R for $2,000 with code P has now signaled that the excess was distributed.

 

 

 

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