excess 402(g) limit - 10% penalty tax

[52626]

Participant exceeded the 401(2) limit for 2015 with two un related plans.

the error was not discovered until AFTER 4/15.

1. Excess is income for 2015.

2. Excess and income will be distributed in 2016 and income for 2016

is the excess subject to 10% since the participant is under 59 1/2? since he was not eligible to defer the amount, I would think the 10% does not apply.

Thoughts

[Tom Poje]

thoughts, for better or worse

. and then the IRS 'thoughts'

the only exception to the 10% early distribution penalty is if the distribution is made before April 15. (unless of course the person is older than 59 1/2) since this involved two plans and neither accepted amount greater than the deferral limit there is no disqualification issue for the plans. that would only apply if it was a single plan.

...........................

the IRS apparently agrees:

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-elective-deferrals-exceeded-code-402g-limits-for-the-calendar-year-and-excesses-were-not-distributed

Consequences of a late distribution
Under IRC Section 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS.
Under EPCRS, these excess deferrals are still subject to double taxation; that is, they're taxed both in the year contributed to and in the year distributed from the plan.
These late distributions could also be subject to the 10% early distribution tax, 20% withholding and spousal consent requirements.
Excess deferrals distributed to highly compensated employees are included in the ADP test in the year the amounts were deferred. Excess deferrals distributed to nonhighly compensated employees aren't included in the ADP test if all deferrals were made with one employer. Excess deferrals distributed after April 15 are included in annual additions for the year deferred.
How to find the mistake:
Ensure that no one's elective deferrals exceed the 402(g) limit for a year by comparing the amount deferred to the 402(g) limit. If anyone exceeds the 402(g) limit and this isn't corrected, the plan could be disqualified.
How to fix the mistake:
IRC Section 72(t) imposes a 10% additional tax for distributions that don't meet an exception, such as death, disability or attainment of age 59 ½, among others. To avoid this additional tax, correct excess deferrals no later than April 15 of the following year. If you don't correct by April 15, you may still correct this mistake under EPCRS; however, it won’t relieve any Section 72(t) tax resulting from the mistake.
Under Revenue Procedure 2013-12, Appendix A, section .04, the permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable both in the year of deferral and in the year distributed. These amounts are reported on Forms 1099-R.

[Lou S.]

No it is not subject to the 10% penalty.

However I believe that after 4/15 you can no longer remove the 402(g) excess. Rather the employee picks it up as taxable income on his 2015 tax return and it is taxed again when it is ultimately distributed from the plan or IRA it gets rolled to.

EDIT - I see Tom has more complete and better info then me as usual. Thanks Tom.

[Tom Poje]

in other words, I think this is what happens (as Lou explained)

1. neither plan is subject to disqualification so there is no reason' for the distribution

2. the IRS has received all the W-2s. they are sophisticated enough to know there are excess deferrals, so the person is taxed on the amount of excess deferral, even though no distribution took place

3. someday in the future the person quits and takes a distribution, thus ultimately he is taxed twice. if he quits before age 55 the 10% penalty applies.

if the person actually received a distribution in this year, how would he ever get taxed a second time on the amount since it is not in the plan?

I think Lou gave an excellent brief explanation, I only used the IRS comments to back my statement

[RatherBeGolfing]

So to sum up

1. The distribution of the excess would be permitted even after 4/15 if the deferrals were made to one plan (under Rev proc 2013-12 Appendix A .04) Otherwise, it is distributed upon a distributable event and taxed in the year of distribution.

.04 Failure to distribute elective deferrals in excess of the § 402(g) limit (in contravention of § 401(a)(30)). The permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable in the year of deferral and in the year distributed. The inclusion of the deferral and the distribution in gross income applies whether or not any portion of the excess deferral is attributable to a designated Roth contribution (see § 402A(d)(3)). In accordance with § 1.402(g)- 1(e)(1)(ii), a distribution to a highly compensated employee is included in the ADP test and a distribution to a nonhighly compensated employee is not included in the ADP test.

2. The distribution is subject to the 10% additional tax under IRC 72(t) unless another exception applies (like attainment of age 59 1/2)

We are having the same 10% discussion in my office this week so this was a timely thread for me to jump in on