403(b) not qualified

[Bird]

A plan was sponsored by an ineligible organization for a couple of years and they just realized the error of their ways. They sent a participant a letter stating that he should include contributions and earnings in income, and that he can't roll over the account.

Just to make it interesting, he's already terminated and rolled over the money to an IRA. My experience with IRA custodians is that there's no way they're going to just return the money and not report it as taxable income, so if he does the right thing and picks up the income from when he made the contributions, he'll wind up with double taxation, or at least the appearance of it, if he takes the money from the IRA and it is reported on a 1099-R.

Any thoughts on both legal and practical approaches (by practical I don't mean illegal, just good ideas)? Obviously if he's going to take money from the IRA and not have it reported as taxable income, there must be a code for disgorging an ineligible rollover, but I can't find it.

[jevd]

A plan was sponsored by an ineligible organization for a couple of years and they just realized the error of their ways. They sent a participant a letter stating that he should include contributions and earnings in income, and that he can't roll over the account.

Just to make it interesting, he's already terminated and rolled over the money to an IRA. My experience with IRA custodians is that there's no way they're going to just return the money and not report it as taxable income, so if he does the right thing and picks up the income from when he made the contributions, he'll wind up with double taxation, or at least the appearance of it, if he takes the money from the IRA and it is reported on a 1099-R.

Any thoughts on both legal and practical approaches (by practical I don't mean illegal, just good ideas)? Obviously if he's going to take money from the IRA and not have it reported as taxable income, there must be a code for disgorging an ineligible rollover, but I can't find it.

When did the rollover occur? IRC 408(d)(4) & (5) address return of excess contributions before & after tax filing deadlines. Code 8 & P will indicate on the 1099R that there has been a return of excess. There is also an exception for bad information given by an employer in a rollover situation.[ 408(d)(5)(B)]

When did the rollover occur and for how much? The exces rollover may be reduced by considering aportion of it as a traditional IRA contribution for the year if eligible. More Facts Needed. Also, if returned by tax filing date including extensions, only earnings within the IRA will be taxed. Penalized if under 59 1/2.

[Guest mjb]

how long long ago were the contributions made to his annuity contract? those amounts that were contributed more than 3 yrs ago are beyond taxation under the s/l.

Jevd: IRA contributions have to be designated on a 1040 tax return and contributed to an IRA by April 15. How does a rollover qualfiy as an IRA conribution if the amount was claimed as a rollover on the 1040 instead of a contribution?

[Appleby]

Jevd: IRA contributions have to be designated on a 1040 tax return and contributed to an IRA by April 15. How does a rollover qualfiy as an IRA conribution if the amount was claimed as a rollover on the 1040 instead of a contribution?

Ineligible rollover contributions not removed timely are automatically deemed regular IRA contributions for each succeeding years, until removed from the IRA.

Amended 1040’s may need to be filed to show the amount as IRA contributions

[Appleby]

My experience with IRA custodians is that there's no way they're going to just return the money and not report it as taxable income, so if he does the right thing and picks up the income from when he made the contributions, he'll wind up with double taxation, or at least the appearance of it, if he takes the money from the IRA and it is reported on a 1099-R.

Any thoughts on both legal and practical approaches (by practical I don't mean illegal, just good ideas)? Obviously if he's going to take money from the IRA and not have it reported as taxable income, there must be a code for disgorging an ineligible rollover, but I can't find it.

The custodian is required to report the amount as ‘taxable amount not determined’, as they would any other regular IRA distribution.

But , as jevd indicated, if the rollover is due to misinformation from the employer/plan sponsor, the distribution amount from the IRA would not be taxable to the participant. The non-taxability of the distribution would be reflected on the 1040, and a note of explanation should be attached

[Bird]

Thanks all. It appears that all contributions were made in 2005 and 2006, and the rollover occurred in 2007, so the s/l has not run on the contributions and there is time to properly correct the rollover.