After-Tax Distribution

[Archimage]

I have a plan with no historical data except for the last few years. A participant is requesting a distribution but I do not have the basis for him. I am going to try to get the employer to try to find the basis for me. My guess is they are not going to have anything. What would be the process for paying this guy out without knowing the basis?

[Belgarath]

FWIW - If the employer/participant cannot provide you with any certified data to prove specific basis amounts, then I think you have to report as all taxable. (Or do a direct rollover) Granted this may ultimately be incorrect, but I don't see that there is any choice. At least that's how I'd do it...

[Appleby]

Belgarath, my concern with rolling it to an IRA is that the IRA owner would now have an IRA for which no basis was reported ( or can be determined) and , resulting in the inability to determine the taxable/non-taxable portion of distributions, possibly resulting in the payment of taxes on amounts that should be tax-free…

Maybe the participant kept the statements from those missing years?

[Archimage]

Appleby, if it ends up that the employer and the participant do not have anything, would you agree with Belgarath that the entire distribution of the after-tax monies be treated as taxable?

[Harwood]

Don't forget the 1099-R:

Box 2b. Taxable Amount not Determined

Enter an “X” in this box only if you are unable to reasonably obtain the data needed to compute the taxable amount. If you check this box, leave box 2a blank unless you are reporting a traditional IRA, SEP IRA, or SIMPLE IRA distribution. Except for IRAs, make every effort to compute the taxable amount.

[Belgarath]

Harwood - good point. Appleby - I agree with you in principle - in fact, that exact thought occurred to me. But Harwood's point also opens up an additional can of worms.

1. For example, if you DON'T offer the participant the opportunity to do a direct rollover, you're in hot water. And if the participant chooses direct rollover, what other choice do you have but to allow it, absent specific data?

2. Can you report a direct rollover as Harwood noted? I don't think so - I would, as my best guess, say that this reporting option is only available for a direct distribution. But that's just a gut feeling - I have no supportable basis for that opinion.

3. If you offer a direct rollover, and the participant chooses a distribution instead, are you obligated to withhold 20%? Or do you withhold nothing, and report as Harwood suggested? I think in this situation I'd withhold nothing and use Harwood's aproach.

Any CPA's out there to jump in on this? It seems like this situation, while rare, might become somewhat more common in the future with the rising popularity of participant loans - some might default, then repay all or a portion. And once a plan has funneled through several recordkeepers, it would be easy enough to lose track of basis...

[Guest LiMar]

I have this situation in year 2012. The client is a small tax-exempt entity. We inherited a take-over plan that includes an after-tax source for 13 participants, the prior provider is unable to provide cost basis, but we can see the amount that is earnings on the last 10 years as there have been no contributions to the Plan. The source totals have doubled in the 10 year period since the original conversion. The vendor who held the plan prior to 2001 no longer has any data on this client (who can blame them). Before I found this post, I told the employer it was their responsibility to provide us with inception to date contribution amounts so we could determine cost basis. Unfortunately, the after-tax portion of the plan was so long ago (1973-1997) that they are no longer using that payroll system and have different people doing payroll. We sent a couple of guys over to the employer's archives to look for data but were unable to come up with helpful data. We also asked the participants and none that we talked to were able to provide any data. The employer is asking us to come up with an "estimate" number that we can use across the board on all participants, for example, assume 60% of the original 2001 converted amount is cost basis. I told them I was not comfortable doing that and that if neither they nor the participant were able to provide cost basis we would have to treat the entire source amount as taxable. I hadn't thought about 1099-R box 2b - which is a great relief to me.

In this situation, a particular retiree is trying to roll over his entire balance into an investment account (IRA) and the broker is extremely anxious to get his money and is telling the participant that we can't hold up his distribution, it's our problem, and who knows what else. I did find IRS Form 4506-T on which we can request W-2 information, but I am not certain that the payroll person would have reported the after-tax dollars as contributions on the W-2 since it didn't affect taxable amounts. Further, the IRS only allows you to request up to 10 years, and by phone I was told they delete everything after 6 years (I have a hard time believing that, but we will see what we get when we request 25 years of data). I also contacted the Social Security Administration to see if we could use Form SSA-7050 for this type of request, but they indicated that they only get total earnings, not any breakdown.

I am at the point now where I am considering paying it out, marking the box unable to determine taxable amount, and sending a cover letter to the receiving broker indicating that the original conversion amount from 2001 (and give him that dollar amount) contains some after-tax contributions that cannot be determined and that he is taking on whatever risk might be associated with that in accepting after-tax dollars into his account, and a letter to the participant indicating that he may be subject to double taxation on this amount if he cannot determine the basis. The employer doesn't want to do that as these 13 people are well-loved long-term employees.

I am trying to do my due diligence in serving this client. I am not seeing any guidance that leads me down a particular path. Does anyone have anything to add on this point? Is there some obscure industry standard that would allow a certain percentage to be considered basis for purposes of paying out a participant?

Any tidbits of brilliance would be very welcome and appreciated.

Thanks!

[ETA Consulting LLC]

I am at the point now where I am considering paying it out, marking the box unable to determine taxable amount, and sending a cover letter to the receiving broker indicating that the original conversion amount from 2001 (and give him that dollar amount) contains some after-tax contributions that cannot be determined and that he is taking on whatever risk might be associated with that in accepting after-tax dollars into his account, and a letter to the participant indicating that he may be subject to double taxation on this amount if he cannot determine the basis. The employer doesn't want to do that as these 13 people are well-loved long-term employees.

I am trying to do my due diligence in serving this client. I am not seeing any guidance that leads me down a particular path. Does anyone have anything to add on this point? Is there some obscure industry standard that would allow a certain percentage to be considered basis for purposes of paying out a participant?

Any tidbits of brilliance would be very welcome and appreciated.

Thanks!

Who killed JFK? Which came first, the chicken or the egg? How much after-tax basis is in the after-tax account of an employer sponsored plan? These three question have one thing in common; you're not going to get an answer. This is merely my weird way of framing the issue

However, the plan sponsor had a responsibility to the participants over time to ensure their after-tax basis was properly tracked within the plan. A failure to do this adversely affects the participants; and there may be some liability issues should the participants pursue legal action. The employer's failure to do this on a wide scale shows that no recordkeeping process to track these amounts were in place when there should've been. Many recordkeeping software systems have a tracking field, but the company the sponsor hired likely didn't know how to use it; arguably creating a failure on the plan sponsors part to hire competent professionals.

If I were a participant faced with potential 'double taxation", I'd seek recourse. The plan sponsor would likely seek recourse through the professional service they hired. This is all a civil issue and tends to be subjective in nature, but the IRS isn't "likely" going to accept an after-tax basis when there wasn't a tracking system.

Good Luck!

[masteff]

Historical W-2 reporting will be entirely unhelpful; part of what we consider standard reporting didn't arise until the tax reforms of the early 80's. If you have contributions dating back to 1973... here's the 1973 W-2: http://www.irs.gov/pub/irs-prior/fw2--1973.pdf Nothing on there would help you.

You have zero legal standing to make an estimate of the basis. You will place yourself in a world of hurt if you go down that road. If the employer cannot provide the numbers from their own records then the burden is on the individual taxpayer.