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withdrawal of excess


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Fact pattern:

In April 2018, sole proprietor sends in $18,000 as a head start on her 401(k) for the 2018 year.  After the 2018 taxes are prepared by the CPA, the Schedule C shows a loss from self-employment earnings.

In April 2019, a distribution is processed from the plan for the 18,000 plus earnings, as a correction of excess annual additions.  No income = no contributions.

The CPA doesn't understand why the 18,327.15 is considered taxable income for 2019.  (At least, not the 18,000 part.)

Should the CPA have reflected the 18,000 as a deduction on the 2018 Form 1040 as self-employed retirement plan contributions?  Typically with refunds of excess like this, the amount is taxable in the year of distribution.  If there had been an 18,000 deduction on the 2018 return, then the 18,327.15 in income for 2019 make sense - just with the suckiness of her tax rate for 2018 being lower than 2019 will be.  That's the typical explanation I'd give for an ADP test refund - the 2019 refund income offsets the deduction for 2018 - but in this case, it's a 415 issue. 

I'm suspecting the solution is either (1) Review the 2018 return to see if an 18,000 deduction is appropriate, OR (2) Change the taxable amount on the 1099-R issued in January so that only the 327.15 gets listed as the taxable amount.

But which is right?   (realizing there could also be a door #3)

Thanks.... --bri

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From IRS website. I think you have an excess 402(g) salary deferral because that cannot exceed compensation/earned income. The $18,000 deferral is taxable income in 2018 and only the $327 is taxable income for 2019. Yes, you also exceeded 415, but I believe this correction comes first.

Timely withdrawal of excess contributions by April 15

  • Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
  • Earnings are taxable in the year they're distributed.
  • There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.

 

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27 minutes ago, CuseFan said:

From IRS website. I think you have an excess 402(g) salary deferral because that cannot exceed compensation/earned income. The $18,000 deferral is taxable income in 2018 and only the $327 is taxable income for 2019. Yes, you also exceeded 415, but I believe this correction comes first.

The implication then is that a deduction should be (have been) taken on the 1040, and the taxable distribution would offset it.  I'd normally say it's crazy to be taking a deduction against a loss but I think that is how it needs to be done.  So this requires an amended 2018 1099-R with whatever code saying it is taxable in the prior year, and an amended 2018 1040.

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The "wash" of $18,000 for 2018 only applies if the excess is withdrawn by 4/15/19.  If the excess is withdrawn after 4/15/19, the result is double taxation.  The taxpayer is denied a deduction of $18,000 in 2018, and the distribution of $18,000 is taxable in 2019 (plus earnings, of course).  

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