Changes in treatment of cash distributions to rollover

[Guest PaulaRafferty]

I have previously informed participants that received an involuntary payout from a 401(k) plan but really wanted to rollover to an IRA/new plan that they must make up the 20% withheld in taxes. I was told that the participant can then deduct what they paid in taxes when they file their return. Does anyone know if this rule has changed at all recently?

Thanks for any help.

[Appleby]

No it hasn’t.

I am not sure if I would use the word deduct -I know what you mean, but the client make take it literally.

The amount withheld will still be considered a pre-payment of taxes. It will either serve to increase the amount the customer receives as a refund or reduce the amount he/she will pay for federal tax

[Guest PaulaRafferty]

Thanks! I just have a quick follow-up question. Can a participant rollover just what she received (the net distribution) to a new employer's 401(k) plan or must she make-up the taxes that were withheld? I think she would have to make up the taxes otherwise after-tax money would be mingling with pre-tax money. It probably depends on the plan document, but most of the documents I have seen prohibit after-tax money from entering the plan.

Thanks again!

[MGB]

They can roll over any amount up to the total distribution. When rolled over, it is not after-tax money and that should be of no concern. The net amount not rolled over (e.g., the 20% withheld), becomes a taxable amount of income. The actual taxes on that amount will be different (a lot less) than the amount withheld and the net between the two will apply to other taxes owed or be refunded when they file next year.