Roth Deferrals and 402(g) Violation

[buckaroo]

Ptp defers 16,500 of Roth into a PYE 12/31/2009 qualified plan. He terminates his position and defers 16,500 of Roth into the qPYE 12/31/2009 ualified plan of his second unrelated employer. The year ends and he discovers that he has violated 402(g), but does not inform his current employer of the violation. Based on this scenario, he would have to "claim" the 16,500 (not CUC eligible) on his 2009 taxes. He would then be subject to taxation when the funds were withdrawn. The issue is since it is Roth, what are the tax implecations. He would not be paying taxes on the 16,500 for 2009 as he has already paid taxes on it (Roth). No earnings would be on the 2009 tax return as he never took a distribution. When he takes the money in the future (assuming that he has a qualified Roth distribution), he would not have to pay taxes on any of it.

Does this sound logical and correct? If so, why would anyone in this situation (or a similar situation) where 402(g) has been violated due purely to Roth deferrals ever inform either plan of the over contribution prior to 4/15? What is the implication for his personal taxes? My untrained tax eye does not see any.

Any comments are greatly appreciated.

[Kathy]

§ 1.402(g)-1 Limitation on exclusion for elective deferrals....

(iv) Distributions of excess deferrals from a designated Roth account. The rules of paragraph (e)(8)(iii) of this section generally apply to distributions of excess deferrals that are designated Roth contributions and the attributable income. Thus, if a designated Roth account described in section 402A includes any excess deferrals, any distribution of amounts attributable to those excess deferrals are includible in gross income (without adjustment for any return of investment in the contract under section 72(e)(8)). In addition, such distributions cannot be qualified distributions described in section 402A(d)(2) and are not eligible rollover distributions within the meaning of section 402©(4). For this purpose, if a designated Roth account includes any excess deferrals, any distributions from the account are treated as attributable to those excess deferrals until the total amount distributed from the designated Roth account equals the total of such deferrals and attributable income.

If I'm reading this right, the Roth Deferrals become taxable when distributed and so do the related earnings?

[buckaroo]

Thanks for the reply. The actual Roth deferrals have already been taxed. So taking the distribution of the actual Roth Deferrals has no tax implications. The related earnings have not been taxed. In relation to a 402(g) excess distribution, both the actual Roth Deferrals and earnings will need to be noted on the tax return, but only the earnings will be suject to the taxes.

My issue revolves around a person who does not take a dist due to 402(g) violation prior to 4/15. I do not think that there is any tax implication for someone who simply notes it on the taxes, but doesn't take the dist. In other words, they get credit in the unrelated plans for both contributions for Roth purposes.

[Bird]

Just reading what Kathy posted, I think you are correct that there are no immediate tax implications for failure to return the excess deferrals by 4/15. But, again just reading from the cite, I think that the excess deferrals (and earnings) are supposed to be tracked somehow and taxed when distributed, whether the distribution was otherwise qualified or not.

On a practical level, if the participant doesn't tell the plan that they are excess deferrals, the plan doesn't know, and the plan would eventually pay out the deferrals as Roth deferrals (i.e. not taxed), and the earnings as well, if qualified.

This is different from regular excess deferrals, where the excess would pretty much be assured of being caught on the current return and taxed in the year of deferral; then it doesn't matter if the plan knows about the excess or not from a reporting standpoint because it is all properly taxed at distribution.

[buckaroo]

Bird, thanks for your reply. So, if a person were to never report the 402(g) to one of the unrelated plans, then they would simply have been able to make Roth deferrals over the 402(g) limit without any implecations?

Just to make sure that I understand this correctly, let's take an extemem example:

Person works for 10 unrelated entities in 2009. The person defers $16,500 of Roth funds into each of the 10 plans and does not inform any of the plans of the deferrals in excess of the 402(g) limit. Therefore, the particpant has defered 165,000. He reports 148,500 on his 2009 tax return, with no tax implications. When he is eligible, he can take a qualified roth distribution out of all plans (165,000 +/- earnings) and receive all of the money tax free.

Correct? Does anyone disagree?

[Belgarath]

Your theory is nice, but the deferrals are reported on the W-2. I think it unlikely that the IRS systems are not sophisticated enough to total the deferrals and kick out the return for scrutiny. And if the employee doesn't get it all corrected prior to April 15th, then the penalty is double taxation, plus of course any other applicable late penalties, interest, etc....

[buckaroo]

I apprecite your response, but I am still a bit confused. I agree that the IRS will be able to determine if someone violates 402(g), but since they are Roth funds and the funds have already been taxed, their should not be any double taxation, correct? The correction is to report on tax return. If funds are not distributed by 4/15, then the penalty to the individual would be that they pay taxes on their form and then again when they are distributed. Since they have already been taxed, then how can it be double taxed?

In addition, I am not an accountant and I am unfamiliar with other applicable late penalties, interest, etc.... Can you detail?

[K2retire]

Or does the failure to correct make the Roth money subject to tax?

[Belgarath]

If the refund is done after April 15th, then the fact that they are Roth does NOT prevent taxation. So they got taxed in the year deferred, (since they are Roth) AND they get taxed when withdrawn. That's the point of the regulation that Kathy quoted. That's where the house of cards falls down.

[Bird]

If the refund is done after April 15th, then the fact that they are Roth does NOT prevent taxation. So they got taxed in the year deferred, (since they are Roth) AND they get taxed when withdrawn.

Are you sure? I think that would be triple taxation. I'm not sure it bothers me, but it seems an unlikely result.

[buckaroo]

My apologies, but I am having trouble with this. Since the plans are unrelated and the the participant does not request the withdrawal timely, the refund then cannot be processed after 4/15. So, is the answer that the participant will have to pay taxes on the monies detailed on the 1040 eventhough he has already paid taxes on it? If so, then I would think that they would at least be gettting the earnings on the overage (when they request their qualified Roth distribution) tax free as well. I assume that the IRS will not track it and the unrelated plans do not even know that there is an issue as they were not notified and a dist was not processed. Is this correct?

[Guest Sieve]

In the year in which the excess Roth contributions are made, they are taxable. In the year in which the excess Roth contributions are actually distributed, they are taxable (including the earnings).

The liability for taxable income is the taxpayer's, not the plan's. If you are suggesting that none of the unrelated employer plans will know that the "Roth" accounts are taxable when distributed, and therefore you can skate on paying the second set of taxes on the Roth accounts when distributions are taken, then make sure you have a toothbrush handy at all times after you have committed tax fraud when filing a return.

[Bird]

QUOTE

If the refund is done after April 15th, then the fact that they are Roth does NOT prevent taxation. So they got taxed in the year deferred, (since they are Roth) AND they get taxed when withdrawn.

Are you sure? I think that would be triple taxation. I'm not sure it bothers me, but it seems an unlikely result.

Never mind on this; i didn't read it carefully enough. It's double taxation.

But...

That's where the house of cards falls down.

But the point is, if it's not reported to the plan, then it stays as Roth money, and there's just no way that it is caught. I'm not advocating it (not reporting), and I don't see Buckaroo advocating it, Buckaroo is just trying to get a handle on the tax effects.

[buckaroo]

Sieve,

I agree that it is a mostly a participant issue. And I am not advocating tax fraud.

However, I do not think it is soely a participant issue. It is also a plan issue (how it is tracked). Here is my issue: If a participant is in this situation and informs the either or both plan administators after 4/15, what is the reccordkeeper supposed to do? I am not sure that it is addressed. it cannot be distributed as there is no distributable event. My thought (and I have no support for it) is to move the contribution over the 402(g) limit (+/- earnings) to a new after-tax souorce. Therefore, when he takes a dist. he will be properly taxed on the earnings.

Issues:

1) What if the plan does not allow after-tax contributions? Forced to amend?

2) How are the earnigns calculated related to any gap earnings? (I ask that b/c the contributions should not have been included at all.)

3) Where is any of this addressed.

4) If this roth deferrals should be moved to a different source (pre-tax), then it should be subjecct to double taxation. If not, then I am still unclear how it will be double taxed.

5) Either way (moving to a different source), the earnings would be properly taxed.

Thoughts?

[Bird]

4) If this roth deferrals should be moved to a different source (pre-tax), then it should be subjecct to double taxation. If not, then I am still unclear how it will be double taxed.

I think that's it (move to pre-tax).

[buckaroo]

Just saw the following link on the daily benefitslink newletter:

From benefitslink newsletter

However, it does not address how the Roth money (to be refunded) should be recordkept...

[austin3515]

I think it should be shifted over to elective deferrals. 401k over 402g is post-tax money in a qualified plan, same as Roth (i.e., because it was not deducted on the 1040). When withdrawn that money is taxed 2x. There shouldn't be a special exception to doulbe taxation for the Roth money.

The only way to make sure the participant pays their fair share of taxes twice (ha ha) is to transfer it to 401(k).