10% tax on excess deferrals returned after 4/15

[AKconsult]

I can't find an existing thread on this topic. Am I the only one that sees conflicting information on this topic?

Code Section 72(t) does not exempt returns of excess deferrals from the 10% early withdrawal penalty; Treas Reg 402(g) states that if the distribution is made on or before 4/15 then it is not subject to the early distribution tax of 72(t), but does not give any sort of exception when it discusses distributions made after 4/15. So those 2 things together would make me think that distributions after 4/15 would be subject to the 10% penalty. Also, the IRS fix-it guide indicates that the 10% tax is applicable if distributions is made after 4/15.

However, if you look at the instructions to the 1099, 1040 and the 5329, there is nothing to indicate that the 10% applies, and actually the Form 5329 specifically states that the tax on early distributions does not apply to distributions of excess deferrals (with no discussion of the timing of the distribution). And we have been speaking to an IRS agent who insists it does not apply even for distributions made after 4/15.

Does anyone have any insight on this? And if the 10% does apply, will it apply to both the years (the year deferred as well as the year distributed)?

[gregburst]

I can't find an existing thread on this topic. Am I the only one that sees conflicting information on this topic?

Code Section 72(t) does not exempt returns of excess deferrals from the 10% early withdrawal penalty; Treas Reg 402(g) states that if the distribution is made on or before 4/15 then it is not subject to the early distribution tax of 72(t), but does not give any sort of exception when it discusses distributions made after 4/15. So those 2 things together would make me think that distributions after 4/15 would be subject to the 10% penalty. Also, the IRS fix-it guide indicates that the 10% tax is applicable if distributions is made after 4/15.

However, if you look at the instructions to the 1099, 1040 and the 5329, there is nothing to indicate that the 10% applies, and actually the Form 5329 specifically states that the tax on early distributions does not apply to distributions of excess deferrals (with no discussion of the timing of the distribution). And we have been speaking to an IRS agent who insists it does not apply even for distributions made after 4/15.

Does anyone have any insight on this? And if the 10% does apply, will it apply to both the years (the year deferred as well as the year distributed)?

I always understood that that a 402(g) excess deferral could not be withdrawn after 4/15. For example, if a 30-year-old participant deferred $18,000 during 2010, then the excess $1,500 must be refunded by 4/15/11. Otherwise, it stays in the plan and gets taxed again when it is withdrawn due to some future distributable event. Regardless of whether the excess is withdrawn by 4/15/11, the participant will be taxed on the $1,500 in 2010 since his personal tax return can only allow a $16,500 deduction.

[Tom Poje]

lets suppose the excess deferrals are distributed timely - oh wait, thats what actually happened, so no 'suppose' is involved.

we turn then to 1.402(g)-1(e)(8)(iii) Distribution of excess deferrals after correction period.

...they may only be distributed when permitted under section 401(k)(2)(B).

[these are the usual rules for distributions for deferrals.] so technically you are not even permitted to distribute the deferrals even though failure to do so is possibly a disqualifying event! How do you like them apples!

For purposes of the person's tax form, he was suppose to attach the W-2's, and those indicated excess deferrals, so if the IRS caught it (or the individual filled out the form correctly), he would have been taxed on the amount in the year it occurred, even though no actual distribution took place. then he will be taxed again in the year of the actual distribution, so he ends up getting taxed twice!!!!

At this point we should stop and say a person could have deferred 10,000 into one plan, quit that job, went to another and deferred another 15000. In that case he has excess deferral, but neither plan is in violation so neither plan is subject to disqualification so no distribution would be made until the person has a distributable event.

if it's in one plan (or one employer) then the plan is subject to disqualification. EPCRS permits the amounts to be distributed (even though 1.402(g)-1(e)(8)(iii) says you can't) because EPCRS is avoiding plan disqualification. (Appendix A.04 of Rev Proc 2008-50(The EPCRS rules)

it indicates you are taxed in the year of excess deferrals and the year the distribution was made. It is silent as to whether the 10% tax applies (but then it is silent to whether such taxes apply in other cases (e.g. min distribution) Everything I've read indicates that in the case of min distribution the 50% excise tax still applies (though of course one could request that tax be waived)

My understanding is that for excess deferrals the 10% premature tax still applies (unless of course the person was age 59 1/2) reason being, you did not meet an of the exceptions to a premature distribution. if it was not viewed as a premature distribution, then it doesn't make sense (at least to me) why EPCRS would have you taxed twice (hence following the rules of the regs found in 1.402(g) which says you can't get the $ out if you are late.

long winded answer enough???

[mbozek]

I can't find an existing thread on this topic. Am I the only one that sees conflicting information on this topic?

Code Section 72(t) does not exempt returns of excess deferrals from the 10% early withdrawal penalty; Treas Reg 402(g) states that if the distribution is made on or before 4/15 then it is not subject to the early distribution tax of 72(t), but does not give any sort of exception when it discusses distributions made after 4/15. So those 2 things together would make me think that distributions after 4/15 would be subject to the 10% penalty. Also, the IRS fix-it guide indicates that the 10% tax is applicable if distributions is made after 4/15.

However, if you look at the instructions to the 1099, 1040 and the 5329, there is nothing to indicate that the 10% applies, and actually the Form 5329 specifically states that the tax on early distributions does not apply to distributions of excess deferrals (with no discussion of the timing of the distribution). And we have been speaking to an IRS agent who insists it does not apply even for distributions made after 4/15.

Does anyone have any insight on this? And if the 10% does apply, will it apply to both the years (the year deferred as well as the year distributed)?

Under 402(g) if the participant does not receive the excess contributions by Apr 15 of the following year then the contributions must remain in the plan and are included in income tax for the year contributed. There is no 10% tax. When the excess contributions are distributed for reasons permitted under 401k, e.g., termination, age 59 1/2, etc they are taxed again. Note this rule only applies to excess contributions which result because the employee contributed to 401k plans of two unrelated employers in the same tax year for which the employee must initiate a request to receive a refund of the excess payment before Apr 15. It does not apply to excess 401k deferrals made to a single 401k plan.

[AKconsult]

Well I am trying to digest it all, and think it through from the standpoint of the taxpayer. In this case, the individual deferred $7,000 too much into 1 plan for 2010. I understand his W2 shows his actual deferral for 2010, but the excess amount should be added to his income on line 7 of his 1040, so he does end up getting taxed on it for 2010. It looks like no 1099 is issued for 2010.

We will distribute the excess plus earnings in 2011. According to the IRS Fix-It Guide, 20% withholding will apply. A 1099 will be issued with codes 8 and 1. The code 1 will subject the distribution to the 10% early withdrawal penalty. The taxpayer would normally report a distribution from a retirement plan on line 16, but the 1040 instructions say that if the distribution is on account of an excess deferral, the excess should be added in with income reported on line 7 instead. However, this doesn't seem to make sense. The 1040 instructions state that if a Code 1 applies for a distribution from a retirement plan, you do not have to complete a Form 5329. Instead, the 10% is calculated on line 58 of the 1040, which references back to line 16, so I think the excess should be reported on line 16, not line 7.

I think the problem is that references to excess deferrals in the tax forms generally assume that the distribution is being made timely (before 4/15) and don't really contemplate a situation in which the distribution is made after 4/15, under EPCRS.

If this doesn't seem like the right approach to anyone, let me know!