Failure to Withhold

[jmrsai]

A participant requested her distribution be split 50/50 between a rollover to her new 401k and a cash payment to her. Through nothing but sheer "OOPS" by the TPA when requesting the distribution, a check for 100% of her balance was issued payable to her new 401k plan but mailed to her home address so that she could submit it with her investment election form for the new plan. She took the check to the bank and they cashed it. The payor of the funds (Nationwide) will be issuing a corrected 1099-R showing a code of "1" and no tax withheld and the participant will be claiming the entire distribution on her income tax return. But, what is the penalty for not withholding? Who is responsible for paying it? (enough blame to go around on this one... TPA,participant, bank that cashed the check). How does it get paid? Is there a form that must be filed?

[SheilaD]

Through the years I've seen many OOPS (and plain wrongheadedness) cause failure to withhold on distributions that should have had withholding. I've never had the IRS come back and "complain". (So far -- knock on wood).

[Bird]

Yep, my understanding is that it would take a participant complaint of some sort to start any kind of correction procedure, and then the plan would have a claim against the participant for the withholding, so it nets to nothing. And I've never seen the IRS do anything about it either; I'm not sure if there is even an official penalty.

[david rigby]

"official penalty"? Who knows?

But, IRC 3405© requires the withholding.

3405(d) says "the payor ... shall withhold, and be liable for, payment of the tax required to be withheld..."

[Belgarath]

There is a penalty under IRC 6672. However, the IRS can abate it if the income tax liability on the distribution is paid by the recipient. I suspect this is why we never hear of a penalty being imposed - if the payor does a 1099, and the participant corrrectly declares it on their income tax return, then they will either owe more - and presumably pay it, or receive a smaller refund. Or maybe the IRS has bigger problems to contend with so this one is generally ignored.

I do have a hazy recollection that it may be a different story if the plan is large enough to be subject to electronic withholding, but our plans are small and never cross that threshhold - so I've never delved into the details. Thankfully!

[K2retire]

If the check was payable to another qualified plan, there was no duty to withhold. The fact that it would subsequently be cashed by someone other than the payee could not have been anticipated at the time the check was issued, so I can't imagine how the paying plan could have any liability in this case.