Repayment of Cash Out Distributions - EE restore?

[legort69]

I have an employee who was laid off in 2003, took a distribution to herself in 2004 and was rehired in 2004 a few months after her withdrawal. My question is that she wants to not have to pay the 10% penalty and income on her withdrawal. She was not fully vested and can restore the ER portion of her match to retain her vesting. Is it also possible to reverse the distribution and restore the EE portion of her account and avoid including in income on the 2004 1099R? I still have to do the 1099R because we withheld 20%.

[QDROphile]

No reversal. Yes Form 1099 on the entire distribution. The amount she pays back to restore the unvested portion is after tax. She does not escape the 10%, but that is none of the plan's business.

[MGB]

I agree. Whether or not taxes and the 10% apply depends on the decisions she made with the distribution in the first 60 days of receipt. If it wasn't rolled over then, it can't be reversed now.

Which brings up an interesting question. If she did roll it over to an IRA then, and repays to the plan now from her own funds (not the IRA), would the amount in the plan going forward be considered after-tax money?

[mbozek]

There are cases and IRS rulings that permit a recission of a taxable event eg. return of stock purchased under a stock opton program, within certain parameters, e.g, the recission occurs in the same year as the transaction, the parties are restored to the same positions that existed before the transaction and state law does not forbid a recission. Never seen it done with a taxable distribution but why should it be any different than a return of funds mistakenly paid to a taxpayer especialy if the return is permitted under the IRC. Problem is that the tax anlaysis will require a lot of resource time.

[legort69]

I want to add that employee works at our TPA firm, which means I am so inclined to assist her with this situation. I was hoping to give her the "employee discount", or even a holiday benefit. The first 2 responses are very firm, but the most recent response shows some wiggle room. I would prefer to have her restore her account and adjust her 1099R rather than give her tax basis which needs to be tracked. Its all in the same tax year. Whats the exposure with that? We're suppposed to be dealing with a more compassionate, friendlly IRS. Happy holidays!

[Blinky the 3-eyed Fish]

But mbozek, this wasn't a mistake but a voluntary distribution. I am not aware of leniency in the 60-day rule for any situation remotely similar to this.

MGB, basically whatever the source of the money paid back, whether that be after-tax or pre-tax, is the how the money should be treated. I recall a discussion on this a few months back.

[mbozek]

This is not a return within 60 days but a return of funds paid similar to Rev. Rul. 79-311. The determinaton to recind the payment should be made after consultaton with counsel.

[FundeK]

Have her send a "sob story" letter to the IRS asking for a waiver of the 60 day rule. They like to issue waivers, don't they?

[Blinky the 3-eyed Fish]

I know it's not a return within 60 days, it's AFTER 60 days. I took a quick read of that promulgation and it's about repayment of advanced commissions. Why is that similar? How do you think that will waive the 60 day requirement in any way? I am cornfused by that cite's relativity to this matter.

[david rigby]

I make it a point to agree with QDROPhile and MGB, especially when they are right, as here.

As mbozek states, there may be special circumstances that the EE could pursue (perhaps a PLR, but who cares?), but that is not the plan's or the sponsor's business. Since the EE was partially vested, likely the $ amount is not large, so the benefit would seem to be small.

W/r/t the attempt to "...assist her with this situation", let's not forget the IRS sometimes take a dim view of anything that might smell of fraud. This is a result of not doing rollover; it is employee's problem.

[mbozek]

General principle that any payment can be returned without tax consequences within the year it is made-thats why it is is called recission.

[Blinky the 3-eyed Fish]

I don't make the leap that that cite provides such a "general principal", especially in lieu of the well known "60-day rule".

[mbozek]

Its not what you think- its what can be done. Under the tax law a transaction that is not permitted under one section can be allowed under another section. Few taxpayers will reverse taxable transactions because of the expense of the legal advice.

[Blinky the 3-eyed Fish]

Never seen it done with a taxable distribution...

Its not what you think- its what can be done

Thanks for pointing that out, but even you don't know if it can be done. This is moot though, so I shall now move on with my life.

[Kirk Maldonado]

While there is authority that has allowed recission, I'm not aware of anything that is even remotely like this. My guess is that the IRS would never approve such an arrangement.

Remember that filing the 1099-R will make it exceedingly easy for the IRS to discover that she didn't pay the penalty tax.

If the employee thinks that she is right, let her fight the IRS. Why should the employer and the plan get involved in this dispute? Why should the employer expend its time and energy to assist the employee in aggressive tax planning? That is a waste of corporate assets (assuming the employer is incorporated).

[mbozek]

It is not unusual in the financial services industry for sales of customer securites to be recinded after the trade has been executed and profits booked to the customers account. No one ever files 1099 on the sale and reports the profits. I dont know of any IRS ruling or reg that permits the practice.

[GBurns]

There will never be enough rules and regs to explain everything and so were are left with doing that which is pragmatic and not specifically prohibited.

Recission means recission and as also pointed out by mbozek, changes, adjustments and corrections etc are allowed within the same year. And although there is a "60 day rule" there is still the "General principle that any payment can be returned without tax consequences within the year it is made-thats why it is is called recission."

That is why although tax deposits are "regarded" as final when the 941 is filed, you can still correct anything for any quarter of the previous year up to the filing of the 941 for the 1st Q of the next year. That is why you can correct a W2 etc even years later.

Whether it be advanced commissions, overpaid salary, bonus, or the sale of securities, the rescission and subsequent correction of IRS etc reports is nothing unusual. And as also pointed out by mbozek there would be no 1099-R etc so

there is no possibility of IRS discovery from this aspect.

That is not to say that this is what should be done here, but it is a valid plan of action.

[Guest TrustMe401k]

While not speaking directly to the question, I think there should be some fear on the part of the employer who is a TPA. If somehow the IRS finds out about this issue and decides it is not a valid correctiopn/change/etc, what is the possibility they might audit the TPA's own plan? And then maybe even start auditing a random sample of the TPA's clients. Sounds like an invitation to the IRS annual ball.

I just don't think it's worth the risk to assist an employee who knew the consequences of his/her decision. Call me paranoid but that's my two cents. (And for you IRS agents that secretly review this website, I did report the two cents on last years 1040!)

[legort69]

In case you are interested to know how it played out, I took the road less traveled, went with the minority opinion, took the aggressive approach that is in line w/ GBurns: I rescinded the withdrawal and restored the account, deleted the 1099R, and am requesting the tax overpayment on the 945 to be returned. I do appreciate all of the responses and have learned a little along the way, but sometimes you have to look at the human aspect of it and I don't think this participant was financial prepared to deal with the tax/penalty consequences. The participant is also aware that there may be possible future tax/penalty issues if the IRS determines that what was done is invalid. Thanks ya'll!

[Guest Pensions in Paradise]

Participant takes out money, then later puts it back. Even if the recission theory is valid (which I seriously doubt), how could this not be viewed as a loan to the participant? Otherwise, mbozek & GBurns have discovered a way for participants to take out money at the beginning of the year and then repay it at the end of the year with no interest.