Withholding on periodic distribution

[bdeancpa]

I have a plan client we are auditing, and one of the distributions we have selected for testing is for a terminated participant who has been taking a flat dollar distribuiton each year. This participant is not subject to RMDs and the custodian is not withholding income taxes on the distribution in accordance with the participant's election on a W4-P completed when the plan was with a predecessor custodian. The distribution appears to me to be an eligible rollover distribution and thus subject to mandatory federal withholding. Does anyone know a reason it would not be subject to withholding?

[Guest Sieve]

It is subject to withholding, but it just is not subject to mandatory 20% withholding. And, the withholding can be waived or adjusted via IRS Form W-4P.

Mandatory 20% withholding only applies to amounts that can be rolled over (i.e., "eligible rollover distributions": IRC Section 3405©(1)), and this periodic payment sounds like it is not an eligible rollover distribution: "any distribution which is one of a series of substantially equal periodic payments (not less frequently than annual) made -- (i) for the life (or life expectancy) of the employee . . ., or (ii) for a specified period of 10 or more years." (IRC Section 402©(4)(A).) If it doesn't meet this exception, then it would be subject to mandatory withholding.

Other distributions (lump sums not eligible for rollover--such as hardship--and periodic payments, as here) are subject to waivable withholding based on the W-4P. (IRC Sections 3405(a)(2) & (b)(2).)

[Laura Harrington]

bdeancpa, a periodic distribution is not an eligible rollover distribution if it is part of a series of substantially equal payments over the life or life expectancy of the plan participant, over the joint or joint life of the participant and a designated beneficiary or over a period of 10 or more years. See IRC 402©(4)(A).

If the distribution you selected for testing meets this criteria, then the payment is not eligible for rollover and the 20% mandatory withholding does not apply. The withholding for periodic payments not eligible for rollover is determined the same as withholding on wages. See IRC 3405(a)(1).