Failed Tests, removing money by 3/15

[Guest Noidy]

When a 401k plan fails testing and must have money removed by 3/15 for an employee, (1) In what year is the refund to the employee taxable? (2) Who reports the refund to the IRS? (3) Does the W-2 for the employee need to be corrected? Thank you for any help you can provide on this subject.

[pmacduff]

If out by March 15th, (1) the refund is taxable to the employee on the prior year tax return (ie., 2001; due 04/15/2002). If they have already filed 2001, they would have to file an amended return. (2) The 1099-R form is completed the following January usually by the Investment Firm or TPA Firm and is coded with a "P" meaning taxable in the previous year. The 1099-R copy for the participant is informational at that point and to be kept with the participant's individual return where the income was reported (2001 in this example). The form 1096 remittance form will notify the IRS that the refund was given before March 15th and was taxable to the participant in 2001 (code "P"). If the individual was audited, the IRS would then check to make sure that the refund was claimed as part of the participant's 2001 income. Lastly (3) The W-2 form does NOT get changed. The individual did defer that amount pretax, and, since they will be including the refunded amount on their personal return, the taxes will be paid. Adjusting the W-2 would result in double taxation of those dollars. Again, the 1099-R the following January to be kept with the 2001 return will provide documentation of the refund and amount. Hope this was helpful.