Disqualified ESOP and IRA rollover

[Guest Anna Lynn]

Circumstances

The taxpayer established a qualified ESOP plan under code section 401(a) exempt from tax under code section 501(a). The plan was terminated several years ago and the taxpayer took the distributions and treated them as a tax-free rollover into a qualified IRA account.

The IRS has audited the plan and has determined that the plan is disqualified. Consequently, the total distribution amount is being included in the taxpayers gross income in the year they were distributed, code section 402(b). Additionally, the distributions constitute an excess contribution under code section 4973.

Questions

Do the funds now have to come out of the IRA because they are no longer eligible? Please include citations/authority if possible.

If so, are they taxed again? Please include citations/authority if possible.

If not, how does the taxpayer "unwrap" the IRA characterization so that he is not taxed again when the IRA account manager issues a 1099R?

What are the administrative procedures between the taxpayer and the IRA account manager and the taxpayer and the IRS?

[Guest Sieve]

At this late date, I don't think there's any way to take these funds out of the IRA without some tax consequences (IRC Sections 408(d)(5)). There is some chance you may be able to consider the rollover to the IRA to be after-tax funds (IRC Section 402©(2)), but I doubt it. You also may be able to treat the contribution to the IRA as after-tax on a serial basis with each passing year, but that may not be possible, either. I'm not an IRA expert, but I think these amounts are all taxable when distributed, since they exceeeded IRA contribution limits. It's not a good result, but I fear it's the way things will have to go. (See, generally, IRS Pub. 590, especially pp. 49-52.)

[QDROphile]

Check out what EPCRS has to say about rolloing over amounts that one thought, mistakenly, at the time of distribution were eligible for rollover. That may provide food for thought about how to approach the issues.

[Guest Sieve]

Anna Lynn -- EPCRS is another name for Rev. Proc. (Revenue Procedure) 2008-50, which you can find many places, including here: http://www.legalbitstream.com/irs_materials.asp?pl=i9

QDRO - Never knew EPCRS dealt with that at all. Guess it's time to re-read . . .

[Guest Anna Lynn]

Thank you both for the information. Maybe I am too literal, but I don't think that Rev Proc 2008-50 applies to this situation nor can I use the approach. The plan in my example is broken beyond repair and no corrective actions can be taken. I also read the parts about the correction of excess amounts, sec 5.01(d)3 and 6.06(2) but I don't see help here either. This plan was terminated in 2004.

I respectfully ask for more direction!!

[Guest Anna Lynn]

Publication 590, page 51, states that if an excess contribution in your traditional IRA is the result of a rollover and the excess occured because the information the plan was required to give you was incorrect, the amounts are not included in the taxpayers gross income. No code or reg reference.

Well, what is the definition of "the information the plan was required to give you was incorrect"?

[BeckyMiller]

This statement is based upon IRC Section 408(b)(5). It refers to erroneous information provided under subtitle F of the Code. Subtitle F covers the Form 1099-R filing requirement.