10% Withholding on Corrective Distributions

[Lori Foresz]

I guess this has always bugged me and I'm hoping to get some clarity.

It was my understanding that 10% federal withholding applied to corrective refunds of excess contributions unless the participants elect out.

Now I am being told by one of the recordkeeping firms, that the 10% withholding only applies if the distribution is made after March 15.

Can anyone shed some light, share some insight.

Many thanks

[Lori Friedman]

The answer depends on both the type and timing of the corrective distribution.

Excess deferrals (exceed the 402(g) limit) - No withholding requirement

Excess contributions (ADP failure) - No withholding requirement if distributed within 2-1/2 months. I.R.C. Sec. 3405 applies after 2-1/2 months.

Excess aggregate contributions (ACP failure) - No withholding requirement if distributed within 2-1/2 months. I.R.C. Sec. 3405 applies after 2-1/2 months.

Sec. 415 annual additions - Subject to the rules of I.R.C. Sec. 3405.

[wmyer]

The recordkeeper is probably confused. For ADP refunds, there is a 10% employer penalty if the excess contribution is refunded after 2 1/2 months after year-end (March 15 for calendar year plans).

[jaemmons]

As this is a non-periodic payment, it is subject to a mandatory 10% federal withholding as prescribed in IRC 3405(b)(1), unless the participant makes an election to not have the withholding taken (IRC 3405(b)(2)).

I agree w/ wmyer that the record-keeper might be confusing the federal withholding with the 10% excise tax prescribed in IRC 4979.

[Lori Friedman]

jaemmons, I respectfully disagree. The federal withholding tax rules for the four types of corrective distributions are described in the instructions to the 2004 Form 1099-R, pages R-3 and R-4. I summarized those rules in my previous message.

[BFree]

Others have opinions on how to interpret 3405.

http://benefitslink.com/boards/index.php?s...t=0entry71567

[jaemmons]

Lori,

I stand corrected. It makes sense, since it is not taxable in the current tax year, to not require any withholding. Thank you for the clarification.