Overpayment revisited

[Guest Retina]

I know there are a number of threads that already address the issue of whether a 1099-R has to be issued for a mistaken distribution (I'll call it the "overpayment") when the participant repays it to the plan. The answer, at least in the case where the overpayment is not recovered until a subsequent year, seems to be a clear yes. I believe the only recourse the participant has then is to pay the taxes owed on the distribution for the year of receipt and then try to deduct that amount on the tax return for the year of repayment.

Let's say the plan recovers the overpayment in the year following distribution but then feels obligated (b/c its mistake created such a substantial tax liability for the participant that it has put him in a hardship situation) to "advance" the amount of such tax liability back to the participant -- the idea being that the "advance" will be treated as an overpayment (and likely be recovered by through the reduction of future payments). Consequences?

[Kirk Maldonado]

Breach of fiduciary duty?

[Guest Pensions in Paradise]

Wouldn't the advance be a prohibited transaction?

[Guest Retina]

I know, I know...

Any thoughts on creative ways to help the poor participant out?

When comparing the benefit of not screwing the participant, the risk that this will ever even make it onto the IRS/DOL radar screen given the relatively meager sum of $ involved (although not meager to the participant) seems low enough (coupled with the fact that if it does, the plan has (arguably) a very good story to tell) to entertain the thought of going forward. Even if there was a fiduciary breach, how bad could the consequences be? If a pt, a small excise tax, maybe, but not much else, right?

[Appleby]

Since the amount was returned to the plan, couldn’t the participant amend his/her tax return to show the amount as non-taxable…as would be done with a rollover amount? If the amount was returned after the 60-day period, then requesting an extension (of the 60-day period) from the IRS may be solution. What do you think?

[TBob]

b/c its mistake created such a substantial tax liability

Whose mistake created the overpayment? Your post makes it sound like the plan made the mistake. I have tried to blame mistakes on "the plan" before but I have a hard time proving that the plan took an active role in the making of the mistake. Usually there is a TPA, Plan Sponsor, Custodian, Fiduciary, etc. behind the scenes that actually made the mistake.

I would suggest that if someone (preferrably the party that made the mistake) is going to help out the poor participant with their financial hardship because of the tax liability, that it be done outside of the plan. It would seem that the risk of creating a PT or Fiduciary Breach by trying to help the participant with an advance of plan assets would definitely outweigh the benefits. Given the meager sum involved, I would think that it should be somewhat painless to put together an arrangement outside of the plan where the participant would repay the advance once the tax matter is settled.

the plan has (arguably) a very good story to tell

I agree that it would be a good story and the IRS/DOL will get a lot of enjoyment out of it!

[Guest Retina]

That's some fancy quoting. Sorry to disappoint - it was a straight-up mistake of the plan's staff, which is why plan itself, w/o prodding by tpa, etc., feels obligated to take action to correct.

[TBob]

I stand corrected. I have never been involved in a situation where the plan actually has employees so I didn't think of that. I have always been on the TPA side of the fence and the finger usually gets pointed in that direction first!

That doesn't change the point of my previous post. I would not recommend the plan try to help the participant with the tax hardship by "advancing" plan assets.

[Kirk Maldonado]

TBob:

You point is still valid, though. I think that there is a lot of risk with the employees of the plan feeling too free and comfortable with the plan assets. Many problems arise because people treat plan assets like they were their own checking account, rather than being subject to a mind-numbing variety of rules.