Overpayment and 1099 Coding Question

[401king]

Recently an overpayment was made to a former participant of one of the plans we administer. We contacted the former participant and were lucky enough to get in touch with the IRA institution in which she rolled the funds into. They are helping us get the overpayment back, but they are going to issue a 1099 with a code 8, which appears to make that distribution taxable for the former participant. In addition, that money was invested and lost about 20% of its value in the month it was invested. Here are some quick details:

Distribution made: $25,500

Correct amount: $23,500

Amount that we are getting back: $1,600 <-- Amount to be reported by the IRA company as income for 2008; to be given back to the plan.

As of now they plan on adding $1,600 to her income by issuing the 1099, code 8, even though the money is going back to the plan of which she is a former participant of.

Does anyone have any suggestions of how the IRA company should be handling this so she doesn't have this overpayment distribution made into a taxable event? 1099 code suggestions? When we issue the 1099 on our end, should it be for 23,500, or 23,900 (to include the amount that was not returned to due decrease in the investment)?

Any advice is welcome. Thanks!!

[Appleby]

Recently an overpayment was made to a former participant of one of the plans we administer. We contacted the former participant and were lucky enough to get in touch with the IRA institution in which she rolled the funds into. They are helping us get the overpayment back, but they are going to issue a 1099 with a code 8, which appears to make that distribution taxable for the former participant. In addition, that money was invested and lost about 20% of its value in the month it was invested. Here are some quick details:

Distribution made: $25,500

Correct amount: $23,500

Amount that we are getting back: $1,600 <-- Amount to be reported by the IRA company as income for 2008; to be given back to the plan.

As of now they plan on adding $1,600 to her income by issuing the 1099, code 8, even though the money is going back to the plan of which she is a former participant of.

Does anyone have any suggestions of how the IRA company should be handling this so she doesn't have this overpayment distribution made into a taxable event? 1099 code suggestions? When we issue the 1099 on our end, should it be for 23,500, or 23,900 (to include the amount that was not returned to due decrease in the investment)?

Any advice is welcome. Thanks!!

You did not say whether the IRA owner provided written instructions to the IRA custodian…so I thought I’d mention that the custodian should not process the transaction without receiving written instructions from the IRA owner to do so...

To answer your question…

Your 1099-R should be for the amount the client should have received.

Code 8 does not necessarily mean that the distribution is taxable. Code 8 means that any earnings on the excess would be taxable in the year that the 1099-R is issued.

If the excess amount is $2,000 and only $1,600 is being returned due to losses, it means that $1,600 would be in box 1 of Form 1099-R, but zero would be in Box 2b. Since Box 2b indicates what is taxable, entering zero would mean that the client would owe no taxes on the distribution.

[401king]

Thank you for your response. We were able to get an answer from an IRS agent affirming your statement. The code would be 8, and a letter would need to be attached to the tax return explaining the situation so the money wouldn't be considered taxable.

Thanks, again!

[jpod]

I don't think there should be any 1099 reporting by the IRA (although you probably cannot successfully fight City Hall on this one). There is no distribution here; it is a repayment of an amount to which the individual was never entitled in the first place, in response to a perfectly valid claim made by the plan. I don't care how the 1099 is coded, this will likely lead to unnecessary and unwarranted aggravation for the participant.

Also, I am having some difficulty rationalizing why the plan is only recovering $1,600. Why does the participant catch a break because he/she lost money on the investments?

[Appleby]

I don't think there should be any 1099 reporting by the IRA (although you probably cannot successfully fight City Hall on this one). There is no distribution here; it is a repayment of an amount to which the individual was never entitled in the first place, in response to a perfectly valid claim made by the plan. I don't care how the 1099 is coded, this will likely lead to unnecessary and unwarranted aggravation for the participant.

Also, I am having some difficulty rationalizing why the plan is only recovering $1,600. Why does the participant catch a break because he/she lost money on the investments?

That would seem like the sensible approach…however, it is an ineligible rollover to the IRA, so it must be corrected as a return-of-excess contribution and reported on Form 1099-R…according to the instructions from the IRS.

[jpod]

Appleby: I had made the assumption that it was a direct rollover, in which case I don't think the excess amount was necessarily a "rollover," invalid or otherwise. If it was not a direct rollover, than I would agree with you.

[Appleby]

Appleby: I had made the assumption that it was a direct rollover, in which case I don't think the excess amount was necessarily a "rollover," invalid or otherwise. If it was not a direct rollover, than I would agree with you.

But it doesn’t matter. Whether it is a 60-day indirect rollover or a direct rollover, the excess amount creates an ineligible rollover which must be removed as a return –of-excess +/- any NIA.

See IRS Pub 590 and IRC 408(d)

[jpod]

If the employer sends too much money to my IRA, why is that a "rollover"?

[Appleby]

If the employer sends too much money to my IRA, why is that a "rollover"?

Because any movement of assets from qualified plan to an IRA is a rollover (whether direct or indirect). Because it is ‘too much money’ the excess amount then becomes an ineligible rollover, and an ineligible rollover must be corrected as a ‘return of excess’ distribution.

[GBurns]

I am confused regarding who can/should issue the 1099, and if one should even be issued at all.

401king said that "they are going to issue a 1099 with a code 8". They being " the IRA institution in which she rolled the funds into."

Without the consent of an account holder, what gives an IRA custodian the authority to correct an account, return a deposit to another party etc etc etc ?

[Appleby]

I am confused regarding who can/should issue the 1099, and if one should even be issued at all.

401king said that "they are going to issue a 1099 with a code 8". They being " the IRA institution in which she rolled the funds into."

Without the consent of an account holder, what gives an IRA custodian the authority to correct an account, return a deposit to another party etc etc etc ?

You would be surprised ( or maybe not) of the amount of custodians that pocess 'reclaims' against IRAs without the IRA owner's permission

[Guest DBS1]

In my last position as the manager of a bank's IRA department, we had this exact scenario in 2008. We (the bank) reversed the original deposit, withdrew the overpaid funds with an nonreportable code and redeposited the correct amount so we would not have to report an excess contribution. We worked with the paying plan to make sure they reported only the correct amount of the direct rollover distribution and we corrected our coding so her 1099-R code G amount would be equal to the rollover amount reported on the 5498. If everyone is on the same page, why put the participant in potential jeapordy by reporting the erroneous amount as an excess contribution? Red flags on tax returns are to be avoided, IMO.

[Appleby]

In my last position as the manager of a bank's IRA department, we had this exact scenario in 2008. We (the bank) reversed the original deposit, withdrew the overpaid funds with an nonreportable code and redeposited the correct amount so we would not have to report an excess contribution. We worked with the paying plan to make sure they reported only the correct amount of the direct rollover distribution and we corrected our coding so her 1099-R code G amount would be equal to the rollover amount reported on the 5498. If everyone is on the same page, why put the participant in potential jeapordy by reporting the erroneous amount as an excess contribution? Red flags on tax returns are to be avoided, IMO.

But it’s not a matter of doing what we thing is easier for the IRA owner. It is a matter of complying with the IRS reporting requirements. If your IRA department gets audited, then it would be found to be out of compliance with the tax reporting requirements for an IRA. For that matter, if an IRA owner makes an excess IRA contribution ( or even an IRA contribution that is not an excess) and wants to have it returned to him/her, why not just wipe the books clean of reporting and just return the amount to the IRA owner ? In the same vein, if an IRA owner takes a distribution and rolls over the amount in 60-days and says…’oops, I should not have taken that distribution after-all and would rather not report it on my taxes’, why not kill the tax reporting?

Why not? Because as an IRA custodian you are required to perform tax reporting in accordance with the tax code and IRS instructions.

[jpod]

Appleby, your analogies do not match the facts. The first issue to be resolved is whether the excess amount was truly an IRA contribution by the individual, rollover or otherwise. The reporting obligations, or lack thereof, flow from that. I maintain that one can take a reasonable position that it was not a contribution by the individual. This appears to be the approach taken by DBS1's bank.

[Guest DBS1]

It was not done as a courtesy to the IRA owner. It was done to correct a transaction. When all is said and done, the bank did meet its obligations to comply. And if the IRS audited the IRA dept., I believe that would not have been an issue. The paying plan overpaid the participant, the participant asked us to withdraw the overpayment. Instead of willy-nilly coding it as a distribution of an excess contribution, which is what the IRS instructs, we worked with the paying plan to refund the money and to reverse the original deposit, redeposit the correct amount so what is reported to IRS is WHAT HAPPENED. I might just be old, but I look at things in wide-angle perspective. We weren't willfully and maliciously bypassing IRS. Things get done wrong. Things get corrected.

[GBurns]

The difference that I see, between the OP and the DBS1 scenario is that in DBS1 is that " the participant asked us to withdraw the overpayment ", whereas in the OP, it is between the plan administrator and the IRA institution.

[Appleby]

It was not done as a courtesy to the IRA owner. It was done to correct a transaction. When all is said and done, the bank did meet its obligations to comply. And if the IRS audited the IRA dept., I believe that would not have been an issue. The paying plan overpaid the participant, the participant asked us to withdraw the overpayment. Instead of willy-nilly coding it as a distribution of an excess contribution, which is what the IRS instructs, we worked with the paying plan to refund the money and to reverse the original deposit, redeposit the correct amount so what is reported to IRS is WHAT HAPPENED. I might just be old, but I look at things in wide-angle perspective. We weren't willfully and maliciously bypassing IRS. Things get done wrong. Things get corrected.

I am not saying that what your approach does not make commonsense, because it does. But commonsense and the regulations/requirements don’t’ always require the same approach. The requirements are that amounts rolled over to an IRA must be corrected as a return of excess, if the amount is ineligible to be rolled over. Reducing the amount reported on the 5498 as a rollover by the ineligible-rollover amount and not reporting the returned of overpayment on a 1099-R does not satisfy the IRS tax reporting requirements.

See PLR 8952011, Rev. Proc. 2008-50 on correcting overpayments to IRAs, IRS Pub 590 on correcting excess IRA contributions-including amounts due to ineligible rollover as a result of incorrect information received from the plan, and the instructions for filing 5498/1099-R.

DBS1, I know that many financial institutions handle the transaction the way you did/do. But I assure you that that is improper procedure.

[Guest DBS1]

There are pages and pages of IRS books full of instuctions for all kinds of things. If anyone can prove they are always followed to the letter in all situations, then I'm dead and not on planet Earth any longer. I learned early on in my career that following the "letter of the law" can be accomplished in more than one way. Applby, I understand your insistance on following the rules, but in my experience, that is not always the way things go. Sometimes you have to be creative while still complying. I strive to meet the compliance regs AND deal with people in a fair and honest way. Also, I would be very comfortable and confident showing IRS exactly what we did in that situation if they inquired about that transaction. IRS agents are people too.

[GBurns]

I think you might have confused "letter of the law" with "spirit of the law ". A dangerous thing to do.

While it is possible to be creative in complying with IRS compliance requirements, in my experience, it seems to usually fail. It seems that most of the proponents of such creativity do not have much experience in being audited.

Yes, IRS agents are people too, but in doing their jobs, they are, first and foremost, IRS agents.

[Appleby]

There are pages and pages of IRS books full of instuctions for all kinds of things. If anyone can prove they are always followed to the letter in all situations, then I'm dead and not on planet Earth any longer. I learned early on in my career that following the "letter of the law" can be accomplished in more than one way. Applby, I understand your insistance on following the rules, but in my experience, that is not always the way things go. Sometimes you have to be creative while still complying. I strive to meet the compliance regs AND deal with people in a fair and honest way. Also, I would be very comfortable and confident showing IRS exactly what we did in that situation if they inquired about that transaction. IRS agents are people too.

After seeing GBurns; post, I think mine is unecessary and not as well said...hence the edit

[Guest DBS1]

I think you might have confused "letter of the law" with "spirit of the law ". A dangerous thing to do.

While it is possible to be creative in complying with IRS compliance requirements, in my experience, it seems to usually fail. It seems that most of the proponents of such creativity do not have much experience in being audited.

Yes, IRS agents are people too, but in doing their jobs, they are, first and foremost, IRS agents.

Yikes, GBurns, you're scaring me. I do have experience with IRS audits. I must be the Mr. Magoo of plan administration because I've been at it a loooooong time. I don't know if I agree that the letter of the law and the spirit of the law are so different, or dangerous. But now you have me under my desk, hiding in my George Costanza under-the-desk suite, and I'm trembling.

I never intended to get into a long argument about this. Obviously, Appleby and you are 100% accurate in your interpretation of the rules. I am trying to say you can follow the rules and still be flexible. I also know IRS agents who are paid to be IRS agents and underneath their IRS agent suits, they are normal people who, in doing their jobs, are looking for abuse and malicious and willful avoidance of following the rules, not for those who correct errors and may skip a step but honestly make every effort to comply. I've worked closely with ERISA and tax attorneys as well. But enough about me...

I want you to post your opinion, Appleby. Robust debate is healthy and informative.

I wish some of the expertise shown on this thread would "appear" on my thread about using employer stock as the vehicle for a SH match. That one really has me wondering about the rules.