Excess deferrals from participation in multiple plans

[Bird]

If a participant exceeds the 402(g) limit, say by contributing $10,000 to each of two plans, who, if anyone, has reporting responsibility if the excess is not timely distributed?

I know, or think I know, that the consequence is double taxation. But what about the mechanics? I'm looking at something that seems to indicate a 1099-R is issued, but how does either plan know to do that, without the participant's instructions/decision as to which plan has the excess? Or is this something the participant handles on his personal tax return?

[Guest Do]

I don't think the plans have a duty to coordinate a distribution amount. It's up to the participant to decide which plan to contact about a distribution, usually from the plan with smaller match. If he or she doesn't, the IRS will learn about the excess because it shows up on his or her W2.

[Lori Friedman]

Have you considered whether the individual is at least 50 years old and if either plan allows catch-up contributions? If yes and yes, the individual has some "wiggle room" and, depending on the actual amounts involved, might not have an excess deferral after all.

If that approach doesn't work, the individual should get her excess deferral (along with allocated income) distributed no later than 04/15/05. Otherwise,

(1) the amount is 2004 taxable income,

(2) the money has to stay in the plan until there's a qualifying event, and

(3) the individual gets $0 basis in the money, even though she's already paid tax on it. Distributions are treated as elective deferrals and included in taxable gross income.

For all the grisly details, please see Reg. Sec. 1.402(g)-1(e)(8)(iii).

As you mention, neither plan is responsible for identifying and correcting the employee's situation. She has to work with one or both of her employers to fix the problem.

[Bird]

Thanks to both of you, but...

I did say that the excess was not timely distributed. Let's say...OK, it IS for 2003.

The problem is not fixable, by either employer. I can't imagine that the participant can/should tell one or both employers to do any reporting, 1099-R or otherwise. I'm concluding that the employee should do something on his 1040 to claim the excess as income. Is that correct? If so, what is (was) he supposed to do?

[david rigby]

Assuming the 2 ERs are not related and could have no knowledge of the other plan, doesn't the burden fall to the individual? Remember that the deferrals are reported to the IRS on the W-2, so the "enforcers" will find out.

[Tom Poje]

Ah, I was working out a Q and A for this situation for the Answer Book. I guess I am allowed to copy my own comments, though I suppose if I am in a grumpy mood I might refuse even myself permission. Well, ok, I will modify it a little. Ok, I modified it heavily. Anyway, this is what I have:

The regulations are quite clear. In order to distribute excess deferrals, the plan must contain language to permit this. But, believe it or not, a plan doesn’t have to. No really, look it up! Treas Reg 1.402(g)-1(e)(4). If a plan doesn't contain such language, it would be impossible to make the distribution.

Now, that being said, it is also required that a plan may not exceed the 402(g) limit for the year – otherwise the plan will be disqualified. Code Sec 401(a)(30) So most, if not all plans, contain the necessary language. But in this case neither plan has exceeded the 402(g) limit. This rule only applies to all plans of an employer, not situations in which an employee works for more than one employer.

Now, it was indicated the violation goes back to 2003. so any correction at this point would be late. and if late, the regs require...

Distributions of excess deferrals after April 15th are only permitted if the employee meets one of the requirements of section 401(k)(2)(B) (e.g. termination, age 59 ½, etc) Treas Reg 1.402(g)-1(e)(8)(iii). Thus, these distributions, depending on the age of the participant, may be subject to the early withdrawal tax, but can only be made if participant has met one of the 'normal' distribution requirements for deferrals.

Now, to avoid plan disqualification, the plan may distribute the excess deferrals under EPCRS (the self-correction program) (Rev Proc 2003-44, Appendix A.04) The permitted correction method is to distribute the excess deferrals to the employee and to report the amount as taxable in the year of deferral and in the year distributed. However, in this case, I don't see where either plan is in danger of disqualification since neither of them violated the 402(g) limit. The rule under the self correction program is for operational failures, and again, I don't see where either plan is in operation failure. (Appendix A .04)

so, what's a body to do? Section 6 .02(2)(a) says correction method should be reasonable, and use the method set forth under 1.402(g)-1(e)(2) would be typical means of correcting failure under 402(g). just because there is no example in the self correction Appendix like this particular case, I don't see why you couldn't use some means of correcting the problem (e.g. distribute the excess from one of the plans). good grief, the self correction program can't list every single means of correcting every situation that will arise. Can't guarentee that this is actually possible under the self correction program, since in this situation you are talking a problem on the individual level, not the plan level.

[Tom Poje]

4979 is on excess contributions or excess aggregate contributions, not on excess deferrals, so I dont think that applies in this case

[Lori Friedman]

SCA, I have to agree with Tom. The I.R.C. Sec. 4979(a) excise tax is paid by an employer, not by a plan participant. In this situation, neither employer has any reason to file Form 5330 or pay a tax.

For the individual participant, the excess deferral (and allocated income) is ordinary taxable income. Also, as I mentioned previously, the individual gets $0 tax basis in what is, in effect, an after-tax plan contribution.

[mbozek]

IRC 402(g)(2)(A)(ii) does not require that a plan allow a participant to remove excess contributions to multiple plans to avoid double taxation. Under 402(g)(2)(A)it is the employee's responsibility to request the removal of the excess contributions by 3/1 since the employers will not know if the 402(g) amount has been exceeded. The separate contributions are reported on the employee's W-2s. There is no disqualfication issue for each plan since the deferral limit under 401(a)(30) has not been exceeded, only the participant's limit under 402(g). If the excess amounts are not removed by 4/15 the excess contributions are taxed as income in the year of deferral (402(g)(1)) as well as when distributed but there is no penalty for excess contributions. After 4/15 the excess can only be removed if a distribution event under 401k occurs. In this case the employee will be assessed income tax on the excess contributions for 2003 but there is no operational failure of the plan.

[Tom Poje]

ah, finally found what I was looking for

hopefully all agree that neither plan is in danger of being disqualified.

hopefully all agree there is no distributable event.

now, I had thought before an ee could be taxed they had to receive a distribution (and a 1099R) but I see I was wrong (again)

11.247 2003 ERISA Outline Book

no 1099R is issued for late excess deferrals distributions. (Some day they will be made)

The person in question should have reported the excess deferrals as income on her tax form, regardless of the fact they received no distribution.

Therefore, person in question should redo their tax form for the year in question.

[mbozek]

Instruction to 1040 form P 19: "Excess salary deferrals. The amount deferred should be shown on Form w-2, box 12 and the Retirement plan box on box 13 should be checked. If the total amount you deferred for 2004 under all plans was more than $13,000 (excluding catchups) include the excess on line 7 (wages)".

The IRS does not mention the procedure to withdraw the excess by 4/15.

The taxpayer needs to file an amended return for 03 with the excess added to wages in line 7.

[Guest Firefly]

If the excess deferal is Compensation (Line 7), shouldn't there be Social Security and Medicare tax? Is it self-employment SE tax?

[Lori Friedman]

Firefly,

No, the income isn't subject to FICA taxation, SE or otherwise. For the amounts deferred in excess of the Sec. 402(g) limit, FICA taxes have already been withheld -- at the time of deferral. As for the allocated plan income, there's no FICA taxation applicable. The taxpayer simply reports the total amount as ordinary taxable income.

[Bird]

  Instruction to 1040 form P 19: "Excess salary deferrals. The amount deferred should be shown on Form w-2, box 12 and the Retirement plan box on box 13 should be checked. If the total amount you deferred for 2004 under all plans was more than $13,000 (excluding catchups) include the excess on line 7 (wages)".

THAT's what I was looking for! Thank you.