Tax Issues for Return of Excess Deferrals

[Guest Dan Simonds]

A 401(k) plan didn't pass testing for year 2000 so about $5,000 had to be returned to the president and one other HCE. A check was just sent to the trustee by the mutual fund company for the amounts. Is it correct that the refunds are taxable income for 2001, the refunds should not be subject to payroll taxes since payroll taxes were already paid on the same money during 2000, and the income should be reported by the company to the employees on form 1099 in early 2002 for the 2001 tax year?

[Guest RBlaine]

IF the refund was made within 2.5 months after the end of the plan year, then it is taxable in the year it was deferred (ie 2000 for a calendar year plan). If the refund was made after the 2.5 months then it is taxable in the year received but an excise tax is due.

They should get a 2001 1099R with the code P (again assuming the deferrals were made in 2000 and the refund was made within 2.5 months of the PYE).

[Guest Richard Scheer]

If the distribution occurs within 2 1/2 months after the close of the Plan Year (3/15 for calendar year plans) then the withdrawal of the excess contributions (+ investment gains) are taxable in the year deferred.

If the distribution is made after the 2 1/2 month period, then it is taxable in the year distributed.

In your case, since the distribution occured after the 2 1/2 month period, you are correct in saying that it should be reported on a 1099-R Form for 2001.

[R. Butler]

If corrections made more than 2 1/2 months after the plan year end, the employer would also be subject to 10% penalty tax on the excess contributions.

[Guest Dan Simonds]

Do you think the 10% penalty for not returning excess contributions (from failed testing - not in excess of the $10,500) before the 2 1/2 month deadline applies to Non-Profit 501©(3) organizations that do not pay taxes anyway?