Failure to withhold taxes

[cpc0506]

Profit sharing plan assets are trustee directed and held in a pooled account. Terminated participant requests a distribution of his vested balance.  Participant completes application for distribution and sends it directly to the investment house.   Investment Company makes full payment to the participant.  What is the penalty, if any, to the plan sponsor for the failure to withhold the mandatory 20% tax from a lump sum distribution to a participant?

[K2]

Two snippets from the EOB

 Collection steps. If the required withholding has not been deducted from a plan distribution, the withholding party should make reasonable attempts to collect the withholding amount from the recipient of the distribution. If future distributions will be made to the recipient, the make-up withholding could be recovered from those distributions. To avoid the penalty under §6651(see the discussion in Part E. of this section), the withholding party may need to pay the underwithholding with Form 945, and seek a refund following the recipient's payment of the tax, or request a waiver of the penalty with the Form 945 filing.

And...

2. Failure to file Form 945. Since Form 945 is a return required under IRC §6011 (see Treas. Reg. §31.6011(a)-4(b)), it is subject to the failure to file penalty under IRC §6651. The penalty also applies to the failure to pay the tax required to be shown on the return (e.g., failure to withhold, as discussed below in Part F. of this Section VI). The penalty is based on the amount of tax required to be shown on the return. A failure to file Form 945 on a timely basis can result in the following penalties from the IRS: (1) a penalty for a late filing of the return, and (2) a penalty for late payment of the tax. The penalty for a late filing is 5% of the amount of the unpaid tax for each month, or part of a month, the return is late, up to a maximum of 25% of the unpaid tax. However, if the return is more than 60 days late, there is a minimum penalty of $100. The penalty for a late payment of the taxes is ½ of 1% of the unpaid tax for each month, or part of a month, the tax is unpaid, up to a maximum of 25% of the unpaid tax.

[Peter Gulia]

If only the retirement plan's trustee had the right to sell or redeem the investment, should the plan's administrator demand that the investment business pay the administrator's expenses, including professionals' fees, for corrections?

 

[Bird]

Realistically, nothing happens.  The participant could make a claim against the trustee, but then the trustee would make a claim against the participant for money they never should have had.  Report it on a 1099-R with no withholding.

[Peter Gulia]

I see the claims, counter-claims, and cross-claims concerning the mistakenly paid amount.

But if a correction kcbirm describes involves some degree of tax-reporting or procedure beyond what ordinarily would be done, shouldn't the mistaken payer bear that incremental expense?

[ESOP Guy]

As a practical matter if you do nothing to correct it I have never seen anyone get in trouble.  What the IRS wants is their money in the end.  If the person reports the income and pays the tax come next April 15th the IRS is good. 

I realize that is not the "right" answer in the sense of how to correct but over the decades I have seen this happen and nothing is done about it and it has never bitten anyone.  My guess is KCbrim's answer is the "right" answer. 

If I recall the risk is if the person for some reason doesn't pay the taxes due on the distribution I believe the IRS can come back to the person/company/plan who should have withheld the taxes and get them to pay the withholding.  Since people who get 1099-Rs report the income and pay whatever is due per the 1040 the risk is small in my mind. 

[BG5150]

I think the IRS would find it more problematic if there is a pattern of not withholding.  If one slips through, I don't think it's a big deal.

[My 2 cents]

Mistake number one was authorizing the investment house to pay upon participant direction instead of requiring input from the plan administrator (especially if the investment house, as seems apparent, lacks the sufficient expertise to properly handle distributions from retirement plans). 

It goes without saying that a 1099-R will be issued at the proper time, properly classifying the kind of distribution and showing, perforce, that no taxes were withheld.  Coming up with the money to pay the taxes due is the participant's problem (at least initially).

As usual, let us not confuse tax withholding and tax liabilities.  The participant will have to declare the distribution on his or her tax return for the year and pay any taxes due (including possibly early distribution excise taxes) without there having been any offsetting withholding.  That nothing was withheld does not excuse the participant from having to deal with the full tax impact of the distribution received (unless it was rolled over by the participant).

[jpod]

Isn't the "payor" (and not the employer) secondarily liable for the 20% in the same way an employer would be secondarily liable for the amount of income tax it should have withheld from wages? 

[Bird]

2 hours ago, jpod said:

Isn't the "payor" (and not the employer) secondarily liable for the 20% in the same way an employer would be secondarily liable for the amount of income tax it should have withheld from wages? 

Maybe, I'm not sure, but...you tell me, if someone's 1040 says they owe money, is the IRS doing anything other than going after them?  It's really a personal tax issue to the IRS at that point.

[jpod]

When it comes to failure to withhold FIT on wages, if the IRS can't collect from the employee, they can and in the right circumstances WILL go after the employer (maybe I should have said "wrong" circumstances).

[My 2 cents]

If someone's 1040 says they owe money, don't they have to send that money in when they file the 1040?  And the 1040 would, one presumes, include any underpayment penalties. 

It is when the participant fails to report earnings as reported to the IRS for them on a 1099-R or when the taxes paid during the year are too far below the taxes actually owed (unless there is a suitable underpayment penalty included) that the participant would be hearing from the IRS.  Of course, most of us think that the IRS may look askew at a financial institution reporting a non-rollover distribution on a 1099-R with no withholding taken out.  So the participant may be more or less OK but not the financial institution issuing the 1099-R.

It's when the participant cannot cover the taxes owed that the problems really take flight.

[ESOP Guy]

40 minutes ago, jpod said:

When it comes to failure to withhold FIT on wages, if the IRS can't collect from the employee, they can and in the right circumstances WILL go after the employer (maybe I should have said "wrong" circumstances).

As I stated above it is my understanding you are correct.  I just have never seen it done in all the decades I have worked in this field.  Maybe it is because not withholding is rare so I have never seen a fact set where taxes weren't withheld and the IRS didn't collect.

 

I think you state a risk just not a very high one.

[Bird]

19 hours ago, jpod said:

When it comes to failure to withhold FIT on wages, if the IRS can't collect from the employee, they can and in the right circumstances WILL go after the employer (maybe I should have said "wrong" circumstances).

Understood.  But I think the point is that it's already too late to do anything about it, other than scold and berate the responsible parties and tell them that there is a remote chance that they could wind up being liable.  There is no other "action" that I know of that will accomplish anything.