1099-R for forfeiture of trustees' benefits to fund missing contributions?

[AndrewZ]

We have a plan under IRS audit - previously, the employer owed some unfunded required matching contributions, and the DOL instructed us to "forfeit" the trustees' accounts to fund those contributions. It did not instruct us to treat those amounts as taxable to the trustees.

The IRS says 1099-Rs should be issued, as the funds are considered "distributed" and then deposited to the plan from the trustees' personal finances. I disagree, as the benefits were treated as forfeitures and transferred within the trust, not actually distributed. In addition, though the trustees made pre-tax deferrals to their accounts, they will realize no personal tax benefits as they have forfeited those contributions.

I do realize that there may be problems with the corporate contribution deductions, if it took deductions for the trustees' 401(k) contributions, and again for matching contributions funded by those same 401(k) contributions... but that's not a plan issue.

Has anyone else encounted this issue with the IRS?

Thanks

[Guest b2kates]

Andrew, the IRS is looking at this as the benefit received by the Trustees, i.e. relief from the obligation. Ordinarily relief of indebtedness is taxable income to the person, notwithstanding the source of funds.

So requiring a 1099-R would be no different that distributing to a child of a participant pursuant to a QDRO, while no distribution is made to the participant it is still taxable.

[AndrewZ]

Thanks, Brett -

But the obligation (to fund the employer contributions) is not directly on the trustees, but on the corporation. The trustees forfeited their accounts to cover for the corporation, but had no direct liability for the funding (except for the fact that are also corporate officers). That's different than a QDRO where the financial obligation is a personal one. So I would think any taxable consequences resulting from this would be on the corporation (e.g. a disallowed deduction for the match which was funded from an alternate source).

[Guest mjb]

The DOL may consider it to be a forfeiture but the IRS regards the transfer of income from one taxpayer to another as an assignment of interest which results in the income being taxed to the person who earns it, not the person who receives it. General rule is that benefits income will be taxed to employee who earns the benefits unless there is a staturory exception (e.g, benefits transferred to ex spouse under a QDRO are taxed to spouse under IRC 402(e)(1). Benefits transferred to a child under a QDRO are taxed to employee under assignment of interest rule.)

[AndrewZ]

Thanks for the responses, I think we'll just go ahead and tell our client that we are issuing 2003 1099-Rs in accordance with the IRS' instructions. It's not a big deal for us to do, and doesn't affect the plan itself.