"failed" direct rollover - obligations of plan?

[msimpson]

Per a member's/distributee's request, a plan prepared a direct rollover check made payable to the eligible retirement plan, gave check to the distributee/plan member for delivery to the payee. The plan member somehow managed to cash the check, even though was not made out to him.

Plan, of course, did not withhold mandatory 20% because it was a direct rollover. Distributee now comes back to plan and asks for a "corrected 1099" showing distribution as ? not sure what, but something other than a direct rollover.

Questions: (1) should the plan correct the 1099R, since the one it issued was presumably correct base on available information? It had no control over the member's ability to improperly cash the check made out to the rollover plan.

(2) if no corrected 1099R should be issued, does the plan have other reporting reuqirements relating to this set of facts, or is this solely a problem now for the member/distributee?

(3) I do not believe the plan should be liable for failing to withhold, under 3405 regs, but can anyone offer additional comfort (cases, PLRs) for me/my client? Q7 of 31.3405©-1 does not contemplate this bizarre set of facts.

[QDROphile]

Report the participant to the police for conversion?

[msimpson]

Report the participant to the police for conversion?

I suppose that is one option, but not sure it will satisfy the IRS, or answer the client's questions regarding its reporting obligations.

[david rigby]

Does the Plan have to do anything? Whose problem is it?

[msimpson]

Does the Plan have to do anything? Whose problem is it?

Ordinarily I would think no the plan does not have to do anything, but for the fact that the plan now has actual notice of what occurred because the distributee contacted us. Does this make it our problem now? I don't know. (Thus, the post!)

[GMK]

It [the Plan] had no control over the member's ability to improperly cash the check made out to the rollover plan.

I assume that the check was properly made out and therefore agree that it is not the Plan's fault. Sounds like the distributee should have followed the age-old advice of consulting a tax or financial advisor before "taking" a distribution from the Plan.

Let the distributee and whoever cashed the check try to explain to the IRS what's wrong with the 1099 that the Plan issued.

As a suggestion for future reference, mail the check to the receiving plan.

[pmacduff]

My 2 cents:

It sounds like the participant wants to report it correctly & I believe that is the IRS's main concern as well. They want to be sure that the taxes (and/or 10% excise) are paid. I think as long as the participant reports it correctly on his personal return, that should take care of it. You don't file the 1099-R with your return unless taxes were withheld which, in this case, they were not.

[Bird]

It sounds like the participant wants to report it correctly & I believe that is the IRS's main concern as well.

I agree. I might be willing to issue a corrected 1099, but the payee could take the position that they accurately reported what they did, and what happened afterward is out of its control and there's no need to do a correction. And if the participant reports it as income, that's what matters.

[GMK]

the IRS's main concern

If the point is whether or not the distributee pays his taxes, then issue the corrected 1099. How else is the IRS to know that the distribution is taxable?

If this guy thinks it's OK to cash a check that is made payable to a rollover receiving account, what's to stop him from using the uncorrected 1099 as evidence of a taxable amount of zero when he does his taxes next year, his integrity?

[J Simmons]

I don't have a cite, but the IRS recently ruled that if the check is made payable to the rollover institution, delivered to the distributee, but not turned over by the distributee to the rollover institution until more than 60 days and then does so, it is nonetheless a proper DIRECT rollover. The IRS explained that the distributee did not have control over the funds because the check was made payable to the rollover institution. So I don't think it is the plan's duty to send the check directly to the rollover institution. Implicit in that ruling is that delivering such a check to the distributee is acceptable.

I would simply r1099-R it as a direct rollover, and leave it as that. From the plan's perspective that is exactly what happened. Effectively for the distributee, it is not much different than if he delivered the check, it was deposited into an IRA for him, and then he withdrew it promptly after that. If the distributee had robbed the bank and took only the amount of the distribution right after it had been deposited in the bank, would you feel the need to tax report it differently if you learned of the robbery? Here the crime against the bank is forgery, not robbery. But either way, it does not involve the plan (the drawee bank might have stand the loss to the forgery victim (here, who knows who that would be) under the law of negotiable instruments).

[jpod]

I agree with JSimmons' conclusion. Way too much brow beating over this one. Plan should do nothing.

[jpod]

I changed my mind. I don't know what the correct approach should be. Now that the Plan has knowledge, should it take steps to prevent the check from being honored? What if it already has been honored? Any banking/UCC experts out there? What are the Plan Administrator's fiduciary responsibilities here if it actually sees a copy of the negotiated check and has proof that it was forged? Interesting question.

[J Simmons]

I changed my mind. I don't know what the correct approach should be. Now that the Plan has knowledge, should it take steps to prevent the check from being honored? What if it already has been honored? Any banking/UCC experts out there? What are the Plan Administrator's fiduciary responsibilities here if it actually sees a copy of the negotiated check and has proof that it was forged? Interesting question.

Per the OP, the check has already been cashed "somehow" by the distributee. Arguably if the IRS is unable to get at least 20% collected from the distributee, the IRS would be considered the forgery victim (the IRS being the third party beneficiary of the mandatory tax withholding requirement). If the IRS could establish that, then the drawee bank (the one that allowed the check to be erroneously negotiated) would have to pay that 20% to the IRS under banking/UCC rules. Whether the plan has a duty under federal and/or state criminal laws to report the crime, if in fact forged, I would have no idea.

Interestingly, the OP explains that the distributee is asking the plan to change the f1099-R that issued reporting it as a direct rollover. I would not change it. I would let the employee simply report the amount of the check as taxable income. I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

[david rigby]

I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

Not disagreeing w/ your comments, is it possible that other taxpayers have a dog in this fight? If the EE uses the existing 1099 as proof that there is no taxable income, then he may have gotten (from his perspective) a "tax-free distribution".

Thoughts?

[J Simmons]

I see it now as an issue between the distributee as a taxpayer and the IRS. The plan correctly reported what it did.

Not disagreeing w/ your comments, is it possible that other taxpayers have a dog in this fight? If the EE uses the existing 1099 as proof that there is no taxable income, then he may have gotten (from his perspective) a "tax-free distribution".

Thoughts?

Other taxpayers are affected, no doubt. But courts have repeatedly held only the IRS has standing to pursue the matter in courts.

I guess the point being, the plan took all steps expected by the IRS of the plan. It reported the transaction accordingly. The distributee has a tax obligation because the distributee changed his/her mind and did not deposit the check into the IRA, instead somehow cashing it. I see it is the IRS's role, not the ER's to enforce the resulting tax obligation from the taxpayer's actions. The distributee's election cause the ER to not withhold 20%, and to report the payout as a direct rollover. At the time of both, the ER had no reason to know differently. It acted appropriately. There are a couple of Tax Court cases that hold if the original return was filed on a good faith belief in the facts that later are discovered wrong, the taxpayer is not obligated to file an amended return. I just don't see how it is the plan's issue upon learning later what the taxpayer did. It's now an issue directly between the taxpayer and the IRS.

[GMK]

Isn't the rollover receiving plan also a forgery victim here? Someone (a bank, mutual fund, etc.) would have been making more money if the deposit to the receiving plan had been properly made. I wonder if the receiving plan ever asked what happened to the money they were supposed to get, but that is not the issuing plan's concern.

Thanks, JSimmons, for the explanation that the plan does not have to issue a revised 1099. Apparently, the only reason to do so would be to honor Mr. Devious' request for a revised 1099, which would inform the IRS that he owes taxes on the distribution he took. But the revised 1099 would show no withholding, so maybe the plan should also attach a note to the IRS explaining why it did not withhold. Hmmm, that works for me.

I'm having trouble with knowingly letting him off tax-free as being a prudent act.

[J Simmons]

Isn't the rollover receiving plan also a forgery victim here? Someone (a bank, mutual fund, etc.) would have been making more money if the deposit to the receiving plan had been properly made. I wonder if the receiving plan ever asked what happened to the money they were supposed to get, but that is not the issuing plan's concern.

Yeah, but no corresponding benefits obligation either. So kind of a wash, except for the investment adviser who would have had more asset-based fees, I suppose. Not the most sympathetic victim for a court to hinge a ruling off of.

Thanks, JSimmons, for the explanation that the plan does not have to issue a revised 1099. Apparently, the only reason to do so would be to honor Mr. Devious' request for a revised 1099, which would inform the IRS that he owes taxes on the distribution he took. But the revised 1099 would show no withholding, so maybe the plan should also attach a note to the IRS explaining why it did not withhold. Hmmm, that works for me.

Read: problems dealing with IRS mailings for months, asking for the 20% from the plan that was supposed to be withheld if you report it as a lump sum payout.

I'm having trouble with knowingly letting him off tax-free as being a prudent act.

The lack of a changed f1099-R does not prevent the distributee from properly declaring the distribution as taxable income. It does not get him/her off the hook and entitled to a tax-free distribution. It's self-assessment, or IRS assessment if audited. In fact, given the fact that the distributee has so approached the plan now and explained what he or she has, it might be tax fraud for the distributee not to report it as taxable income. That's separate and apart from the fact of the f1099-R, which is the issue for the payor plan.

[GMK]

Thanks, John. You've clarified it for me (once again).

I admit to being one of Mr. Rigby's other taxpayers, upset that this crook is likely to pull off his tax free distribution scheme.

Of course, it's springtime, from which blossoms the hope that he will do the right thing. 'Past performance is no guarantee of future results' works both ways.

[rcline46]

The IRS actually matches the 1099-R rollover with a 5498. When the match fails there will be an audit of the plan, requests for front and back of ALL checks for that year - an imposition on both the TPA and the client. I would fix the 1099-R and only if questioned on the withholding issue disclose what happened. If you do electronic filing of the 1099-R, it can be fixed now. If paper filing must be a corrected 1099-R.

[msimpson]

The IRS actually matches the 1099-R rollover with a 5498. When the match fails there will be an audit of the plan, requests for front and back of ALL checks for that year - an imposition on both the TPA and the client. I would fix the 1099-R and only if questioned on the withholding issue disclose what happened. If you do electronic filing of the 1099-R, it can be fixed now. If paper filing must be a corrected 1099-R.

Is a 5498 filing required only for IRA's, or for any receipts of an eligible rollover distribution? (From the form, looks like only for IRA's.) I need to get more facts from my client as to the intended recipient of the direct rollover.

My concern with "fixing" the 1099-R is that it may suggest that it was improperly reported in the first place. I do not want to subject them to penalty assessments for improper reporting, even though they have very good reasons for arguing that no penalty should apply.

[rcline46]

The OP said it was a rollover check - I don't think it was specified as another plan or an IRA. The 5498 is issued only by IRA entities, not plans. So determining the original target is a factor.

[GMK]

msimpson - I recommend that you consider JSimmons' comments very carefully.

Since the issuing plan did things correctly and is under no obligation to issue a revised 1099, it shouldn't. The plan does not need to become a party to Mr. Devious' web of deceit.

Furthermore, if the plan were to issue a revised 1099, then the plan, not the crook, will receive the on-going requests from the IRS for the withholding (ref. post #17, above), which would be an unwelcome and avoidable penalty on the plan.

Of course, the plan may wish to confirm all this with its own attorney.

[Kevin C]

I'll take a seat on the fix the 1099 side of the table.

There are a couple of Tax Court cases that hold if the original return was filed on a good faith belief in the facts that later are discovered wrong, the taxpayer is not obligated to file an amended return.

Would that apply if the filing instructions say that you must file a corrected form? The general 1099 instructions, section H, page 6 says

If you filed a return with the IRS and later discover you made an error on it, you must:

• Correct it as soon as possible and file Copy A and Form 1096 with your Internal Revenue Service Center (see part D on page 5).

Has anyone actually had the IRS come back after the plan for 20% withholding that wasn't done?

How would the IRS know from the corrected 1099-R that it wasn't a hardship distribution where 20% mandatory withholding would not apply?

[Jim Norman]

If you filed a return with the IRS and later discover you made an error on it, you must:

• Correct it as soon as possible and file Copy A and Form 1096 with your Internal Revenue Service Center (see part D on page 5).

Plan did not make an error, participant made first error and bank honoring the check made second error. It is not the plan's responsibility to correct other party's errors. It would be a third error for the plan to issue a 1099-R that did not reflect what the plan actually did, which was to pay a distribution in the form of a direct rollover.

[Belgarath]

FWIW, I come down on the side of those who believe the plan has no responsibility to "correct" anything. Plan reported it correctly.

As an aside, not that it matters in the least, but it doesn't appear that this participant is trying to avoid paying taxes. In the original post, the participant is asking that a 1099 showing a rollover actually be corrected to reflect something else, which presumably would be a taxable distribution.

"Distributee now comes back to plan and asks for a "corrected 1099" showing distribution as ? not sure what, but something other than a direct rollover."

[Kevin C]

How is it a direct rollover if the payment didn't make it to an eligible retirement plan? The plan is responsible for making sure the 1099-R correctly reports how the distribution was paid. The plan tried to pay it as a direct rollover, but the participant managed to change it into a direct distribution. Now that the plan knows about it, they know the information on the 1099-R is not correct.

[Belgarath]

Hi Kevin - we'll just have to agree to disagree on this. What about a situation where the receiving company deposited it into a non-qualified annuity account instead of a qualified IRA annuity? Is it still the plan's responsibility to "correct" a mistake that was made by another party? Or into a non-qualified mutual fund account, rather than a qualified IRA account? I'm sorry, but there are a zillion things that can go wrong that are beyond the control of the plan, and for which it doesn't seem to me that the plan is responsible, even if it is later told about the error. Now, I may be dead wrong in my opinion, but I know that if a similar scenario was brought to us and the client wanted a corrected 1099, we'd tell them to fry ice.

Of course, with any luck, we'll never have it happen!

[GMK]

it doesn't appear that this participant is trying to avoid paying taxes.

Really? (BTW, I agree that this doesn't matter to the plan.)

Let's see.

1. He requested this rollover distribution, which he could have requested be paid to him (but that would involve 20% withholding).

2. He gets the full payment by cashing a check made payable to someone else, which is highly irregular and in some places illegal.

3. Next spring, he looks at his 1099 (or his accountant looks at his 1099), sees that the taxable amount is zero, files his taxes without including the payment as income, and Bob's your uncle.

Step 3 is speculation, but I see it as the most likely conclusion to steps 1 and 2, which he has already taken. Of course, past performance does not guarantee future results, so he may "remember" to pay his taxes on this payment.

Kevin C - The plan did pay the distribution as a direct rollover. It issued a check to the rollover receiving account. The participant did not change it into a direct payment. The participant stole the money by illegally cashing a check that was made payable to someone else.

The plan's 1099 correctly reports what the plan did. The plan should not now help cover up a crime.

[Belgarath]

GMK - I don't dispute at all that your step #3 is possible, but since the the participant has already specifically taken step 2a, which is to actually request a corrected 1099, then it seems that tax avoidance isn't the goal. Of course, it may occur to him later, especially if he reads these boards.

Also agreed that cashing the check seems irregular and or illegal. I wonder if it really was properly made out to the other institution, or if it was incorrectly made out - in which case, I might agree with Kevin.

[GMK]

I wonder if it [the check] really was properly made out to the other institution, or if it was incorrectly made out - in which case, I might agree with Kevin.

msimpson could check on the details of the check, but the OP says the check was "made payable to the eligible retirement plan," so I figured it was not made payable to the distributee. Then again, I tell people to 'assume nothing.'

At the risk of repeating myself, mail the check to the receiving plan.

[masteff]

My 2 cents is I'd do a corrected 1099. The Service has both the original and the new one on file so they know the plan thought it was a rollover hence no withholding. Your next best alternative is to tell the participant to file form 5329, this is exactly the type of purpose for which that form exists.

And GMK, the OP says:

... Distributee now comes back to plan and asks for a "corrected 1099" ...

So while I'm sure the type of fraud you're alluding to has been done, it doesn't appear to be the case here unless we want to borrow worries. And we really ought give someone who's come forward and asked for a corrected 1099 the benefit of innocent until proven guilty.

[Kevin C]

I had client a few years back that cashed in an annuity policy that was an investment in his PS plan to fund a participant loan. The insurance company issued him a 1099-R showing a taxable distribution of the entire proceeds. I contacted the insurance co on behalf of my client. The insurance co rep told me they filled out the 1099-R based on their records and that their legal department said they had no responsibility to amend the 1099-R and that they would not, under any circumstances, amend the 1099-R. Sound familiar?

I wrote a letter for the client to sign pointing out that the 1099-R they prepared was not correct since it was a participant loan, not a distribution. I included copies of sections of the 1099-R instructions with the passages relating to correcting the forms highlighted. Back then, the instructions included a blurb about how you might be sued if you intentionally filed incorrect information on a 1099. The letter closed with a promise to pursue legal action if the 1099-R was not corrected. About a week later, we received a sheepish call from a manager at the insurance company who informed us a corrected 1099-R was on the way.

I'm not saying they are required to investigate each distribution to make sure nothing went wrong. I'm just saying that I think they can not ignore it after they find out the participant somehow cashed the check.

GMK, I don't understand how you think amending the 1099-R amounts to covering up a crime. I think issuing a 1099-R showing no taxable distribution when the payee knows the participant cashed the check is more likely get you in legal trouble.

Belgarath, you are right, we'll have to agree to disagree on this one.

[GMK]

masteff - You are correct. He's innocent of tax cheating unless and until he does it.

He did come back and ask for a corrected 1099, but originally he came and asked for a rollover distribution. And when he decided he wanted cash instead, he did not request a "corrected" distribution. Instead he cashed a check that was not payable to him (not so innocent an act) and thereby just so happened to bypass withholding.

I think Mr. Norman is correct in calling a corrected 1099 the third error.

And if the plan accommodates this guy under these circumstances, they need to be careful that they are not less accommodating to future participants who play fast and loose with distributions.

I very much like your suggestion of using a form 5329 in this situation.

I had client a few years back that cashed in an annuity policy that was an investment in his PS plan to fund a participant loan. The insurance company issued him a 1099-R showing a taxable distribution of the entire proceeds. I contacted the insurance co on behalf of my client. The insurance co rep told me they filled out the 1099-R based on their records and that their legal department said they had no responsibility to amend the 1099-R and that they would not, under any circumstances, amend the 1099-R. Sound familiar?

Sorry, but it doesn't sound the same to me. In this case the insurance company did not do what the participant requested, presumably because for some reason the insurance company's records did not specify that the distribution was to fund a loan. In the OP, the plan's records were accurate, it correctly issued the rollover distribution in accordance with the participant's request, and it documented the distribution correctly in the 1099R.

The 1099 reports what the plan did. As long as the 1099 reports the rollover distribution, and the check was made payable to the rollover receiving account, the plan has done what is prudent and right, and it does not share any responsibility for the distributee's later misdeeds. If the plan issues a revised 1099 indicating a direct payment, then the plan is saying that the original 1099 was wrong. In so doing, the plan acknowledges that the distributee's highly questionable post-distribution finagling was an action that the plan recognizes as legitimate under its distribution procedures and which requires the issuing of a corrected 1099.

And I, too, agree to disagree on this one. Thanks to all for an interesting discussion.

[TPAMan]

The only way to correct this is for the participant to return the proceeds he received from the 'forged' check and have the plan/trust reissue it as a taxable distribution to the participant.

I know of no other way to remedy a seemingly fraudulent activity.

[J Simmons]

I'll take a seat on the fix the 1099 side of the table.

There are a couple of Tax Court cases that hold if the original return was filed on a good faith belief in the facts that later are discovered wrong, the taxpayer is not obligated to file an amended return.

Would that apply if the filing instructions say that you must file a corrected form? The general 1099 instructions, section H, page 6 says

If you filed a return with the IRS and later discover you made an error on it, you must:

• Correct it as soon as possible and file Copy A and Form 1096 with your Internal Revenue Service Center (see part D on page 5).

Unless the statute enacted by Congress requires a corrected form and the IRS instructions are merely reflecting that (or they are found in 'legislatively mandated' regulations), I don't think the IRS can lose a couple of cases it challenges the taxpayer on and get around the result merely my making such a statement in form instructions.

[J Simmons]

How is it a direct rollover if the payment didn't make it to an eligible retirement plan? The plan is responsible for making sure the 1099-R correctly reports how the distribution was paid. The plan tried to pay it as a direct rollover, but the participant managed to change it into a direct distribution. Now that the plan knows about it, they know the information on the 1099-R is not correct.

I think the plan did more than try to make payment as a direct rollover. The plan did make a direct rollover payment. The IRS accepts the plan's doing so by providing to the distributee a check made payable to the rollover institution. The f1099-R properly reflected that, particularly given the knowledge of the plan at the time it issued the f1099-R.

[Kevin C]

So, at what point do you consider the distribution paid, where nothing that happens in the future has any bearing? When the check is mailed? When the check is received by the payee? or something else?

[J Simmons]

So, at what point do you consider the distribution paid, where nothing that happens in the future has any bearing? When the check is mailed? When the check is received by the payee? or something else?

when the check is mailed per the law of negotiable instruments, and the obligation is then satisfied (given that the check is not dishonored by the drawee bank)

[masteff]

So, at what point do you consider the distribution paid, where nothing that happens in the future has any bearing? When the check is mailed? When the check is received by the payee? or something else?

when the check is mailed per the law of negotiable instruments, and the obligation is then satisfied (given that the check is not dishonored by the drawee bank)

In which case the correct answer to the OP is instruct the participant file form 5329 in order to fix it on their own tax return. The 5329 gets overlooked alot as a solution to fixing coding problems on 1099s.

[birdstothebowl32]

Good morning,

I have a similar question, a client had a SIMPLE plan with himself and just one other employee as participants which was opened in 2018 with Recordkeeper X.  in 2019, he decided to move the SIMPLE to Recordkeeper Y so he told Recordkeeper Y to set up a new SIMPLE that would be ready to receive the rollovers.  Howe/er, the client already had a SEP account with Recordkeeper Y.  As you guessed, Recordkeeper Y placed the SIMPLE rollovers from Recordkeeper X into the SEP account instead of a newly established SIMPLE account (this being in 2019, its less than the 2 year rollover limit).  The client only just found out about this issue now as he trusted Recordkeeper Y was doing things correctly and has been maxing out his contributions to the SEP (supposed to be SIMPLE) for 2020.  I understand that the IRA holders can request a rollover back into a new SIMPLE account (which Recordkeeper Y should pay earnings on) and self-certify as to the mistake to avoid any penalties but what about the status of his original SEP and current/former SIMPLE plans; is this a significant operational failure?  Does he as owner have any duty under EPCRS/VCP to correct the failures or should he just get a letter from Recordkeeper Y that they messed up acknowledging liability and keep it on record in case of audit?

[BG5150]

On 4/6/2010 at 11:43 AM, david rigby said:

If the EE uses the existing 1099 as proof that there is no taxable income, then he may have gotten (from his perspective) a "tax-free distribution".

The 1099 won't be "proof"  Code G implies a direct rollover.  There wasn't one.

On 4/6/2010 at 12:31 PM, GMK said:

upset that this crook is likely to pull off his tax free distribution scheme.

I don't this guy is a 'crook.'  Looks like he changed his mind and is trying to do the right thing an claim the income.

The only think he "gets away with" is the 20% withholding.  But he's just gonna have to make up for that and pay the tax.

Crummy situation, and I would just send a revised 1099-R, code 1 or 7, no withholding. 

IRS comes knocking, what you you (the plan administrator say)?  Guy said he was going to rollover the money, we put code G.  Then he told us, and we saw, this did not happen.  So we corrected the form to show what actually happened.

[BG5150]

Oh, shoot.  I didn't realize I was responding to an 11-yr old post...my apologies...