Eligible rollover distribution to a tax-exempt payee

[Carol V. Calhoun]

This is an off the wall question, but I'm kind of going around in circles trying to figure out an answer. A plan participant named a tax-exempt organization as a beneficiary. The plan paid the distribution as a lump sum. Since it was an eligible rollover distribution, the plan withheld at a 20% rate. The tax-exempt would (obviously) like to get the withheld money back.

First question: Should the plan have withheld? While it might be common sense that a distribution to a tax-exempt entity should not be subject to withholding, I'm not finding any exception to the 20% withholding requirement for tax-exempt payees, either in section 3405 or the regulations thereunder.

Second question: Now that the plan has withheld, what should the tax-exempt do? Since they don't file income tax returns, what form would they use to file a claim for refund under these circumstances.

Has anyone here dealt with such a situation?

[mbozek]

This is an off the wall question, but I'm kind of going around in circles trying to figure out an answer. A plan participant named a tax-exempt organization as a beneficiary. The plan paid the distribution as a lump sum. Since it was an eligible rollover distribution, the plan withheld at a 20% rate. The tax-exempt would (obviously) like to get the withheld money back.

First question: Should the plan have withheld? While it might be common sense that a distribution to a tax-exempt entity should not be subject to withholding, I'm not finding any exception to the 20% withholding requirement for tax-exempt payees, either in section 3405 or the regulations thereunder.

Second question: Now that the plan has withheld, what should the tax-exempt do? Since they don't file income tax returns, what form would they use to file a claim for refund under these circumstances.

Has anyone here dealt with such a situation?

1. If this a death distribution why isnt this a charitable bequest under IRC 2055 instead of a designated distribution subject to 20% withholding? Distributions to a charity are not eligible for a rollover.

2. If the participant directed that part of the LS distribution payable to him be paid to a charity then it is taxable as a distribution to the participant under the assignment of interest rule and is subject to 20% withholding. Participant gets a charitable income tax deduction for amount paid to charity (80%) and amount withheld may be eligible for a refund.

3. Refund of withholding will be paid to taxpayer from whom the tax was withheld. Who was the taxpayer from whom the 20% tax was withheld?

4. If this was some other type of transfer please describe.

[Bird]

I'm not sure if I can find a cite but logic says that the charity can't roll it over so they're shouldn't have been withholding. To get the money back, (I guess) the charity would have to file a return, even though it wouldn't normally have to.

[jpod]

I think MBozek hit the nail on the head: How did it qualify as an ERD if the distributee was an entity?

[masteff]

I'm not sure if I can find a cite but logic says that the charity can't roll it over so they're shouldn't have been withholding. To get the money back, (I guess) the charity would have to file a return, even though it wouldn't normally have to.

The nonspouse rollover rules as discussed in Notice 2007-07 reference 401(a)(9) for the term "designated beneficiary" and direct us to Reg 1.401(a)(9)-4. There we find Q&A-3 which says only an individual may be a designated beneficiary. Ergo, a tax-exempt organization is not a designated beneficiary and cannot elect to rollover. So as said above, it was never a rollover eligible distribution.

Second question: Now that the plan has withheld, what should the tax-exempt do? Since they don't file income tax returns, what form would they use to file a claim for refund under these circumstances.

You could probably pay it to them and then file a 945-X to fix it from your side.

[QDROphile]

How about it is not an eligible rollover distribution, so the "regular" nonperiodic payment rules apply. The withholding is 10% unless the payee elects a different amount. The charity elects zero withholding.

[mbozek]

How about it is not an eligible rollover distribution, so the "regular" nonperiodic payment rules apply. The withholding is 10% unless the payee elects a different amount. The charity elects zero withholding.

Great idea but according to OP plan withheld 20% of distribution to charity.

If the distribution is paid as a bequest due to death of participant there is no withholding because payment is IRD to charity under IRC 691(a) for which there is no withholding since charity is tax exempt.

[Carol V. Calhoun]

Thanks, all! I was getting lost in the multiple cross-references.

[ERISAAPPLE]

I have an issue similar to the one Carol had, except we have not yet made the distribution to the tax-exempt entity.  Do we withhold at 10% under 3405 and not allow the entity to make an election (because under the statute only individuals can opt out of withholding).    I could read 3405(e)(1)(B)(ii) very broadly to mean no withholding is required if it is reasonable to believe the distribution will not be subject to tax, but I don't think that is the better interpretation of that provision.  It just seems odd to withhold on a distribution to a tax-exempt entity.  Also, do I report the distribution on a 1099-R?  I feel comfortable saying a 1099-R is required, so the entity can report the income on its Form 990.    

[Bird]

The one time - that I can remember - that we paid a charity, we did not withhold, and we issued a 1099-R.  If the statute says that only individuals can opt out, I guess we didn't know and/or ignored it.  There were no subsequent problems.

[ERISAAPPLE]

1 hour ago, Bird said:

The one time - that I can remember - that we paid a charity, we did not withhold, and we issued a 1099-R.  If the statute says that only individuals can opt out, I guess we didn't know and/or ignored it.  There were no subsequent problems.

And I take it you did not file a Form 945?

[Bird]

945 is only required if there is withholding.  We may have filed one because of other distributions, but not for this.