Withholding on ineligible deferrals

[hunter001]

Does a 10% federal withholding apply for corrective distributions on ineligible deferrals. Such as participant made deferrals without being eligible.

[masteff]

I'd say yes, but the participant can opt out.

[dcoderre]

I agree. The distribution is not eligible for rollover, so the lump sum federal withholding rate is 10% unless the participant opts out. State withholding rules also apply, with some states allowing for opt out. I'd report the distribution on 1099-R with Code E to indicate it corrects an error, and hope the IRS is not aggressively using this code for targeted plan audits...

[hunter001]

I have been using code 2 and no withholdings. When they go to file their taxes they would be taxed on this then? Also, for corrective ADPACP distributions I don't withhold fed taxes unless its past the 2 1/2 mo deadline. Do you know if this still holds true?

[rcline46]

The 10% rule applies to the adp/acp givebacks UNLESS the participant has elected otherwise. The 2 1/2 month rule only has to do with excise taxes paid by the employer and has nothing to do with the employee.

[dcoderre]

It's true the 2-1/2 month rule for distribution of excess contributions for ADP failure no longer impacts withholding because PPA now requires the distribution to be taxed in the current year. In accordance with IRC 3405, distributions taxable in the current year are generally subject to 10% withholding if ineligible for rollover. The 2012 Form 1099-R instructions are silent about excess contribution & excess aggregate contribution withholding, but it's my understanding they are subject to withholding per IRC 3405. The 1099-R instructions do indicate correction of 415 excesses are subject to withholding; however, correction of 402g excess deferrals are not subject to withholding. See 2009 explanation from Relius at: http://www.relius.net/News/TechnicalUpdates.aspx?ID=434