Mandatory withholding correction

[Guest ANNEBV]

Former Participant takes cash distribution of entire vested account balance. 20% mandatory withholding is mistakenly not withheld. Looking for suggestions on how to correct. Will try to get former participant to return 20% to trustee so that it can be remitted to IRS. If not, Employer may have to "make participant whole". If this is the case, how does Employer do this? On what amount is 20% determined? The total amount that the participant received (mistakenly) or the original amount that he should have received? What are penalties for late payment of mandatory withholding? Where is this addressed in Code/Regs?

[Guest]

this looks like a strange one from what I have read. (ERISA Outline Book)

if required withholding is not taken from the distribution, the IRS may recover the withholding tax (Plus interest) from the withholding party (plan administrator or payor). see 'trust fund recovery' penalty under IRC 6672.

generally this is abated if the tax is actually paid by the recipient.

so...

recipient gets a 1099R noting distribution. based on the above, it almost looks like recipient could ignore paying taxes and put the burden back on the administrator or payor. of course, in my belief that most people are honest, when filing taxes people will include the 1099, note the distribution and pay the full amount of taxes. remember, the 20% is not the actual tax, if recipient is in higher tax bracket he will have to pay additional tax anyway. but, that is my opinion only.

[Alf]

Whether it is withheld by the employer or not, the tax is due by the employee.

Withholding is just a method of securing the payment of taxes to the government. It is not a tax itself. Therefore, the employee would owe the same taxes whether or not the employer withheld, there are just fewer "pre-paid" amounts that can be offset against the employees tax liability if there is no withholding.

Normally, employers are not responsible if their employees do not pay taxes. However, if the employer fails to follow the mandatory withholding rules, the employer can be liable for the tax if the employee does not pay. The employee would have to fail to pay his taxes (not a common occurence)in order for the employer to be liable. Also, I do not believe that the employer would be the first source of funds tht the IRS would look to. I assume that the IRS would first look to levy the taxpayers other assets.

[david rigby]

Is this a 1999 transaction? if so, nothing has been reported to IRS, and (at least theoretically) it can be corrected.

Is the participant aware of the problem? If the distribution is still liquid, then ask to have it reversed. It might be OK to reverse only the 20% withholding, but I would reverse the entire thing if possible and then do it right.

[Guest ANNEBV]

Yes, it's a 1999 transaction. Agreed that it can be corrected, theoretically. However, the participant received the cash distribution quite a while ago...this error was just recently discovered. Participant is also considered a "difficult" person, according to client (aren't they always when something like this happens??!)...not likely to cooperate, if asked to do so, according to client. We're trying to determine best method of "correction" to recommend to client, along with all related ramifications. I'm inclined to send him 1099 with $0 withholding, let him pay appropriate tax and see if he questions anything. Any further feedback from anyone???

[david rigby]

I think the 1099 with $0 withholding is correct from the EE's perspective.

But you still have the problem with the IRS that the trustee failed to do proper withholding. You probably need some good advice from a tax lawyer to build your case.

Is it possible to ask the IRS anonymously what they think the solution is?