failed ADP test after HCE fully paid out

[Tom Poje]

tripped across the following in the 1099R instructions

I've seen this topic discussed before, but never the comment about putting something in the margin of the 1096. (Never had this situation before, not quite sure how you would do this if you file electronically)

If you make a total distribution in 2014 and file a Form
1099-R with the IRS and then discover in 2015 that the
plan failed either the section 401(k)(3) actual deferral
percentage (ADP) test for 2014 and you compute excess
contributions or the section 401(m)(2) actual contribution
percentage (ACP) test and you compute excess
aggregate contributions, you must recharacterize part of
the total distribution as excess contributions or excess
aggregate contributions. First, file a CORRECTED Form
1099-R for 2014 for the correct amount of the total
distribution (not including the amount recharacterized as
excess contributions or excess aggregate contributions).
Second, file a new Form 1099-R for 2014 for the excess
contributions or excess aggregate contributions and
allocable earnings.
To avoid a late filing penalty if the new Form 1099-R is
filed after the due date, enter in the bottom margin of Form
1096, Annual Summary and Transmittal of U.S.
Information Returns, the words “Filed To Correct Excess
Contributions.”
You must also issue copies of the Forms 1099-R to the
plan participant with an explanation of why these new
forms are being issued.

[Bird]

Interesting*/thanks.

*Well, it's what passes for interesting in our world.

[401 Chaos]

May I add another possible layer of interest? Does anybody have experience with a similar situation but where the plan failing the ADP test is terminated and has all assets distributed before corrections are made?

As best I understand the facts, Employer 1 was bought in late 2013 and Old 401(k) was terminated in connection with transaction. Executive went over to buyer, Employer 2, and rolled his entire account balance from Employer 1's Plan into Employer 2's Plan in January 2014. In February 2014, Old Plan informs Executive that Old Plan failed ADP testing for 2013 thus requiring a return of $X to Executive. However, because Executive rolled her entire account balance out of the Old Plan to the New Plan, the Old Plan must recharacterize $X as an excess contribution for 2014 and thus will be issuing Executive two separate 1099-Rs in 2014--one for the entire amount rolled over (less the $X recharacterized as excess contribution) and a second 1099-R reflecting the $X recharacterized as an excess contribution for 2014.

Fast forward to January 2015 when Old Plan does as promised and issues 2 separate 1099-Rs to Executive. Executive tells New Plan that $X in excess contributions were rolled into New Plan and need to be removed. New Plan says it can simply kick out $X by sending payment to Old Plan / Trustee to be paid "for benefit of Executive" and code this as "18/ G (rollover) on a 1099 to avoid showing as taxable distribution. Old Plan's record keeper, however, refuses to accept a return and says it cannot accept any funds from New Plan as Old Plan was terminated and all Old Plan assets were distributed in late 2014. Record keeper helpfully advises best to have New Plan distribute $X to Executive, report the distribution on a 1099-R, and have Executive explain to the IRS what happened. (Maybe they should just add a note in the bottom margin?)

Executive is stuck between two large bureaucratic record keepers and left trying to find simplest way to avoid potentially getting taxed twice on the $x distribution. Any thoughts?

[Tom Poje]

there is an odd regulation, not sure how it actually works in practice


Within 12 months after the close of the plan year in which the excess contribution arose, the plan must distribute to each HCE the excess contributions apportioned to such HCE under paragraph (b)(2)(iii) of this section and the allocable income. Except as otherwise provided in this paragraph (b)(2)(v) and paragraph (b)(4)(i) of this section, a distribution of excess contributions must be in addition to any other distributions made during the year and must be designated as a corrective distribution by the employer. In the event of a complete termination of the plan during the plan year in which an excess contribution arose, the corrective distribution must be made as soon as administratively feasible after the date of termination of the plan, but in no event later than 12 months after the date of termination. If the entire account balance of an HCE is distributed prior to when the plan makes a distribution of excess contributions in accordance with this paragraph (b)(2), the distribution is deemed to have been a corrective distribution of excess contributions (and income) to the extent that a corrective distribution would otherwise have been required.

[Treas. Reg. § 1.401(k)-2(b)(2)(v)]

[401 Chaos]

Tom,

Many thanks for your post.

Although the rollover in our case was actually made in the year after the excess contribution arose and so should not technically need to rely on the exception permitted in the regulations cited here (i.e., as I understand the regulation, this basically provides an exception that allows a plan to treat the excess portion of a rollover as an excess distribution even though not made after the close of the plan year in which the excess arose as is typically the case), I believe the Old Plan is following the same rationale and similar guidance suggested by splitting the rollover amount and reporting on two separate 1099s--one for the excess portion and the second for the permitted rollover amount. In short, I think the Old Plan has done just what it probably should do here in terms of reporting the excess contributions that got included as part of the rollover.

By the same token, I think the New Plan is acting appropriately as well. I don't think there is any way it can simply distribute the excess without reporting it on a 1099 even though it knows the excess amount was reported previously by the Old Plan. (Plus, at this stage, there are probably additional earnings on the excess to be reported that weren't reported by the Old Plan.) While the New Plan might code a distribution on the 1099 to show it as a nontaxable rollover back to the Old Plan as a typical remedy to the receipt of an invalid rollover, the Old Plan refuses to accept the amounts because the Old Plan has since been terminated.

In looking at the Form 1099 instructions, I don't see any codes or guidance that might permit the New Plan to distribute the excess directly to the participant but somehow report or code the distribution in such a way that the participant gets credit for the amount already reported as a taxable distribution by the Old Plan. I also don't think there is any way the Old Plan can (or really should) amend its 1099 filings to show the entire rollover amount and just let the New Plan report the full excess amount kicked back. The participant here is just sort of stuck facing double reporting through no fault of his own.

If there is no way to address as part of the 1099 reporting here, wonder if there is any way to really advise the participant on explaining the situation to the IRS so that it doesn't become an audit risk or extended hassle.