Distribution paid by employer not plan

[pam@bbm]

While preparing the 12/31/2016 accounting for a pooled profit sharing plan, I just found out today that the employer paid a terminated participant her vested balance of $684.  Her account is all safe harbor non-elective funds, so she was 100% vested.   The distribution was done a year ago in April 2016.   The problem is that it was paid from the employer's checking account, not the plan's checking account.   Since it wasn't paid from the plan, no taxes were withheld and no 1099R was issued.     The employer did not include the amount in her W-2 either.   I know the plan cannot reimburse the employer.   I'm not sure how to fix this.   Can the plan pay her the $684 and she then write a check back to the employer?  

[ETA Consulting LLC]

The issue here is that the payment from the plan should happen regardless of anything that the employer has previously done; as the plan's trust is a separate legal entity from the employer.  So, the idea that he employer wrote a check does nothing from a plan perspective; where the participant's right to that distribution must still be enforce (without any consideration of what previously transpired between the employer and that participant).

Once the participant gets the proceeds, then she is free to do what she pleases.  She may choose to reimburse the employer or keep the funds; but that would be her choice to make.  This goes to the very foundation of qualified plans and serves as a lesson; NEVER confuse plan assets with company assets.  A participant's plan balance should be paid from the plan; not the company.

Good Luck!

[Mike Preston]

I'm going to go in a completely different direction.  While I don't think it matters as to what happens from here on out, I like to know the complete circumstances so can the OP, PAM, please report as to whether the amount received was rolled into an IRA or other qualified plan? 

The theory that has the best optics is one that revolves around the liquidity exception relative to the prohibited transaction rules.  Of course, claiming that this applies requires one to substantiate the plan having a lack of liquidity....probably a tall order.

Notwithstanding the liquidity exception, this happens all the time.  The "solution" is to restore the plan to the position it would have been in had it made the distribution properly and otherwise report what actually happened.  So, issue a 1099-R with the payor being the plan sponsor.  It is late. Have the plan "re-pay" the "loan" (if you think the liquidity exception applies) or "reimburse" the plan sponsor for having advanced the distribution. Consider reimbursing less that the full amount if the plan has suffered a loss between the two dates, but if it is really a pooled account, I'd be sorely tempted to ignore earnings completely in the determination of the re-payment.

A bit messy and that is always a bit discomfiting.  But double paying doesn't seem right to me, either.

As always, we recommend that ERISA counsel bless the course of action, whatever is decided.

[RatherBeGolfing]

How about option three?

1.  Issue the 1099-R from the plan

2.  If it is participant directed, move the plan assets to a suspense account and use to offset future contributions.  If a pooled account, the assets stay in the account.

3.  The payment from the employer is a "contribution" to the plan for 2016. 

The end result is a 1099-R from the plan, the participant received the correct amount, and since we count it as a contribution, the plan is in the same position it would have been in had a distribution and contribution taken place

 

[BG5150]

I think that would only work if the ER did not file its taxes for 2016 yet.

[ESOP Guy]

48 minutes ago, RatherBeGolfing said:

How about option three?

1.  Issue the 1099-R from the plan

2.  If it is participant directed, move the plan assets to a suspense account and use to offset future contributions.  If a pooled account, the assets stay in the account.

3.  The payment from the employer is a "contribution" to the plan for 2016. 

The end result is a 1099-R from the plan, the participant received the correct amount, and since we count it as a contribution, the plan is in the same position it would have been in had a distribution and contribution taken place

 

Given the small amount of money this is how we would have done it back when I did balance forward PSPs.  It would have been a "do to ER" on the plan's balance sheet and that would offset a future contribution to clear the payable. 

 

[pam@bbm]

Thank you for the responses.  Mike, It was a cash distribution, not rollover to IRA or other qualified plan.   I think I'm leaning toward option 3. 

[My 2 cents]

Is it safe to say, at the very least, that the employer has learned its lesson?

Treating it as a contribution and benefit distribution would be sensible if (a) it were a defined benefit plan and (b) the deadline for 1099-Rs and individual tax filings had not passed.

Ideally, the plan would have timely issued a 1099-R.  There is a probably compliance failure here, since the employer probably did not give the participant the appropriate notice and rollover forms.

[mstick]

Plan sponsor may also want to consider assisting the participant in covering the cost of amending the participant's tax return due to the late 1099-R.