K1 Partner(s) exceed 415 because K1 will report a loss

[jkharvey]

Employer deposited amounts that were "deferrals" for the partners. After year end the K1s report a loss. The "deferral" amounts have to be returned to partners as there is no compensation. The Partners' CPA says that no 1099R should be issued and this is not a taxable distribution. I can see the argument that since the partners received no tax deferred "benefit" from these distribuitons. Money is going to come out of the trust. How is the 1099R supposed to be handled? Thanks.

[Bird]

I believe there is a 1099-R code for 415 excess refunds. Maybe we don't have to bother reporting rollovers since they are not taxable...?

[jkharvey]

Yes, there is a code for the 415 excess. That still generates a taxable event for the participant. The CPA is saying, however, that there should not be a taxable event. The participant never received any deferral of taxation benefit on this amount. I'm wondering now if this should be a mistake of fact that is returned to the employer. Anyone have thoughts on that?

[QDROphile]

If amounts in excess of the 415 limit got into the plan, the plan has an operational failure. I don't think mistake of fact works, at least in the IRS view. This was not a mathematical error. Greed + rectal cranial inversion is not a mistake of fact. The idea that the correction is not a taxable event for the particpant has merit, but the anaylysis needs to be done under Rev. Proc. 2013-12.

[austin3515]

This is not a 415 failure. These were not eligible deferrals. They had no comp, so they were not eligible to defer. That's how I see it anyway.

[Tom Poje]

I'm not sure I would refer such an issue as 'greed' or anything like that. even in the preamble to 401k regs the IRS noted
One commentator asked for clarification of the interaction between these timing rules and the rule under the regulations that treats a self-employed individual’s earned income as being currently available on the last day of the individual’s taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner’s draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual’s actual earned income for the relevant period.

It could well be at the start of the year business was good and the ee deferred early as permitted, but then business went downhill and the sched C ended up insufficient.

since the person, at least in this case, had no income, I don't see how the person could get a distribution - those $ simply didn't exist for them.

whether those $ get tossed into a forfeiture account or returned to the company to pay 'expenses' (which I guess is why the sched C income was negative) I'm unsure.

[Lou S.]

Here is a thought that may be crazy but what about doing a refund of deferral and earnings but call the deferral after tax basis since they were not deducted in 2014?

The net effect is the taxable portion of the refund would simply be the gain/(loss).

[austin3515]

_{I think it needs to go to the forfeiture account. I actually think refunding it to the employer as a mistake of fact is not a bad option either though, but one would need to do some research. I think if you look up the criteria for mistake of fact refunds to the employer this might hit all the criteria.}

[QDROphile]

Greed: "self-employed individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits"

What part of "make sure" failed here?

If it is not a section 415 failure, it is still an operational failure: Improper contributions were made to the plan.

[austin3515]

QDRO Phile, are you suggesting that partners in all cases should know that the last half of the year they will lose money? I think you're asking a bit much of mere mortals who haven't got the ability to see into the future.

In many cases the margin between money making and losing is narrow too by the way. Not all partners make $100K.

[jkharvey]

Love this discussion..thanks everyone. Why would it not be considered 415 since compensation is zero? That is a theoretical question.

I like the idea of forfeiting the amounts. I don't think now that I read all of this that the amounts go back to the participants since they never came from the participants.

[Tom Poje]

my thoughts would be:

the company was going to pay me 10,000.

I deferred it all into the plan.

now it turns out, no, the $ weren't there, there was a bill for 10,000 that was paid instead.

Therefore that 10,000 was never really mine.

If I get the distribution for 10,000 it's like saying

I have 0 comp, but I get 10,000 anyway. but that would be impossible.

I need to put the plan back in a position it should have been.

if I had 0 comp, I have 0 deferral, so no distribution to me.

[austin3515]

Any thoughts pon the mistake of fact approach to get it returned to the employer?

[QDROphile]

With respect to "make sure" there is a special rule that treats all K-1 compensation as being received as of the last day of the year. That allows K-1 partners to have elective deferrals determined and contributed after the end of the year with respect to all compensation for the year, unlike W-2 employees. As we know, the elections still have to be made before the end of the year. Partners in businesses that have unpredictable results can "make sure" they stay within the limits by having the contributions determined after the end of the year after compensation is determined. Partners who have the luxury of different circumstances may "make sure" as appropriate under the circumstances.

I don't think mistake of fact cuts it, but that is not the only avenue of return of the improper contributions to the employer. I am more tolerant of returning mistaken contributions to the employer under Rev. Proc. 2013-12 than a lot of the contributors to the message boards.

[austin3515]

^{I've always been bothered by posts that place a higher expectation on people than is really reasonable. Perhapsh you'll be horrified by this comment, but for most partners they don't spend a lot of considering such things. They're just putting money in their 401k based on the assumption that because they've always been able to participate the same should be true this year. Therefore, I personally think no less of them when they find themselves in this situation. I actually sympathize with them because if they had been paid via w-2 wages for the "profitable" part of the year they would not be in this situation.}

[QDROphile]

I try to focus on what the law is and how to comply with it.

There is no reason to tax aspects of qualified plan benefits; the law is all artifice and policy. Those who want the benefits, especially if they want to maximize them, have to take into account that is all rules and no logic except some internal logic sometimes. They may also take into account that the rules are complex and enforcement is mimimal. Compliance can be a bother and I tend toward cynicism rather than horror.