402g violation correction

[K-t-F]

I looked at old posts... here is what I found.

If a participant is in 2 plans and ends up over deferring for 2003, one plan needs to distribute the excess prior to the current year end, 2004. That plan will issue a 1099R and the participant will be responsible for taxes on the overage in the year of the distribution (2004). Also, the participant's W2s for 2003 will show that he/she over deferred and will end up being taxed for the overage. Double taxed!

What else? anything?

[Harwood]

It the overage is disgorged prior to April 15, the coding of the 1099-R is such that there is no double taxation.

[david rigby]

If a participant is in 2 plans and ends up over deferring for 2003...

Doesn't it matter how this happened? For example, if the two plans were from unrelated employers?

[E as in ERISA]

Yes.

First I would note that the distribution must generally be made prior to 4/15 (of the following year).

However, if the plans are related, then there is potentially a disqualification issue. So ERCRS can be used to correct the violation after 4/15.

If the plans are unrelated, then there is no qualification issue. EPCRS does not apply. No correction after 4/15.

[K-t-F]

If the plans are unrelated, then there is no qualification issue. EPCRS does not apply. No correction after 4/15.

This is not my plan so I will find out... but, if they are not related you do not correct? the $ stays in?

[david rigby]

I think Katherine is pointing out that the 402(g) limit is an individual one, rather than a plan limit. If the person contributed in two unrelated plans, and exceeded the limit only in total, then neither plan is responsible for "causing" that excess. However, the IRS will find out since the amounts are reported on the W-2. The person can expect a letter from the IRS, but probably not the plan.

[K-t-F]

I understand that it is an individual limit... are you saying that neither plan needs to make a correction and that the individual will simply be penalized by the IRS for the mistake? If so, what will the penalty be? an excise tax based on the amount of the over deferral?

[Guest Benmark]

I have a participant who also informed us, after April 15, that she overdeferred in 2003. Our trustee is telling us that we cannot correct this since we were informed after the April 15 deadline. Is that correct? What does she do?

Thanks!

[Tom Poje]

well 1.402(g)-1(e)(8)(iii) states that excess deferrals may only be distributed when permitted under 401(k)(2)(B) (That would be to have a distributable event )

As mentioned earlier, since this is not a plan problem (the excess deferral was due to aggregation of unrelated employers) there simply is no correction I know of - in fact why bother anyway.

1. ee had excess deferrals and pays taxes in year deferrals were made.

2. since excess deferrals not distributed timely, ee will pay taxes a second time.

3. neither plan is not in danger of disqualification. that is the only reason for using self correction.

4. therefore, whether the ee gets the distribution this year or in a later year is a moot point.

5. after April 15, there must be a 'legitimate' reason for the distribution - termination, age 59 1/2, death, disability.

6. in this case there is probably no distributable event, so therefore the $ sits until such event occurs

at least that is the way I understand it.

7. employee has learned a costly lesson - or employee goes to H & R Blockhead (or similar tax preparer) and complains that the tax preparer should have noticed this problem and make them pay the penalty.

[mbozek]

Under 402(g) if the funds are not refunded by 4/15 the excess contribution is taxed in both the year of contribution and again in the year of distribution which is permitted from a qualified plan, eg. termination, age 59 1/2. There is no effect on the plan if the excess results from employee deferrals to separate salary reduction programs.

[Harwood]

1. When these excess deferrals get distributed years from now, aren't they technically ineligible for rollover? Are systems tracking this?

2. It is almost like after-tax basis has been created. There is money in the deferral source that has already been taxed.

[Tom Poje]

well, in the eyes of the IRS...hmmm. EyeAreUs...

no after-tax basis is created. you simply end up paying taxes twice, no matter how unfair that is. That being the case, perhaps there is no rollover issue - after missing the APril 15 deadline the excess deferrals would appear to be treated like any other defrral.

(I have never seen the issue of rollover addressed before)

[mbozek]

The excess is regarded as an employer contribution which will be taxed a second time when paid. I dont see any prohibition in a rollover since employer funds are rolled over on a pre tax basis and will be taxed when distributed from the IRA. The penalty for excess contributions which are not refunded is double taxation of the employee - once in the year the excess is contributed and again when the employee receives the amount.

[Harwood]

If it is treated as an employer contribution, how is it tested?

[mbozek]

Arent all salary reduction contributions treated as employer conributions when they are distributed?

[Harwood]

"If it is treated as an employer contribution, how is it tested?"

What I am asking is if this excess is treated as an employer contribution, is it like a discretionary profit sharing contribution and now this person - perhaps an HCE - has a higher rate of accrual than everyone else?

[mbozek]

? Harwood: the excess is part of a salary reduction contribution to each employers plan subject to the ADP test for HCEs. It is an excess contribution to the employee for distribution purposes because the total contribitions from each plan exceed the 402g limit. By the way the refund provision of 402g for excess contributions is in most 401k plan documents.

[Harwood]

It was this statement: "The excess is regarded as an employer contribution" that made me ask the question about testing. It implies a discretionary employer contribution, not an employee contribution subject to the ADP test.

[Guest Vreez]

I want to return to Harwood's question posted 6/21/04 about the testing of excess deferrals. We have a client who has a 401(k) plan with a cross-tested profit sharing contribution feature. In 2003, the owner makes excess deferrals (total deferrals of $18,000 - don't ask how), but these excess deferrals are returned prior to 3/15/04. The owner then contributes a profit sharing contribution for 2003 to max himself out under 415. When running the 401(a)(4) non-discrimination testing, are the excess deferrals that were returned considered in the test? As this seems to result in a maximum annual addition of $34,000 ($40,000 - $6,000 excess), it doesn't seem fair.