De Facto After-Tax Contributions

[Guest RJRogers]

This issue was raised on the 'IRAs and Roth IRAs' board in the hope a Roth conversion might offer a solution to the potential double taxation problem it presents. That now seems unlikely. It is being repeated here to garner a broader 401k perspective.

A 401k profit sharing plan is maintained by an LLP. A Partner in the firm executed an elective deferral agreement when first eligible a number of years ago authorizing reductions equal to the annual Section 402(g)(1) limit and additional annual profit sharing contributions have been added to his account up to allowable maximum. However, annual K-1 statements issued on the Partner's behalf have never reflected these amounts and Partner's accountant never took them into account in figuring taxable income. Consequently, these amounts have de facto been made with after-tax dollars.

Amended returns will be filed for open tax years. The problem is what, if anything, can be done (now or in the future) to avoid being taxed a second time on allocations made doring the closed tax years when distributions ultimately occur?

[masteff]

I suppose you could try filing for a Private Letter Ruling from the Service asking permission to convert the money to after-tax. But if they permitted that, I think it'd only be for the deferrals and not the profit-share. And you'd have to ask permission to retroactively amend the plan to allow after-tax if not already allowed.

[QDROphile]

Were the profit sharing amounts (A) not presented in the in the K-1 at all, or (B) included, but not identified as an item that reduces income (or identified but not properly reflected on the Form 1040)? If (A), then the taxpayer did not pay any taxes with respect to the amount. If (B), the taxpayer failed to claim a reduction of income. While there may be a remedy for some years for the failure to claim the reduction, I don't think that makes the contribution an after tax contribution. Assuming that the plan terms do not provide for after tax contributions, this is a personal income tax problem, not a retirement plan issue.

The situation may be the same for the elective deferrals. If the plan does not provide for after-tax contributions, the problem is on the reporting/claiming side and it is unlikely that the plan will provide the resolution. From the plan's perspective, nothing is amiss. Failure of the employer to claim a deduction is a personal/corporate income tax problem. I don't know enough about personal income tax to know if masteff's suggestion has any realistic hope. I know only of IRS sanctioned retroactive amendments to plan for the sake of resolving a plan qualification problem, not an individual income tax probem. Many income tax deductions are overlooked, and there is a limited time and method for claiming them if they are discovered.

[jpod]

Either (a) someone filled out the k-1 incorrectly, (b) k-1 was filled out correctly but someone handled 104 incorrectly, or © both (a) and (b) or some combination of the two. I agree this is a personal 1040 problem, not a problem that can be fixed vis a vis the plan. I would run, not walk, to a good plaintiff's/professional negligence lawyer. While SOL for some tax years may be closed, the SOL for a negligence action for some or all of those years may still be open.