Ineligible Rollover & 1099-R

[Zoey]

A participant terminated employment in 2016 and took his account balance.  Since he rolled part of his account, took part in cash and had a defaulted loan, he received three 2016 1099's.  However, the plan erroneously paid out all of his account PLUS his loan balance.  For example:  His account balance was $50,000 plus $10,000 loan balance, for a total of $60,000.  The 1099's were issued for exactly what he was entitled to, but not what he actually received.  One 1099 was for $25,000 in cash, one 1099 was for the defaulted loan ($10,000), and one 1099 was issued for the rollover for $15,000.  BUT, what he actually received was; $25,000 in cash, $10,000 (defaulted loan) and $25,000 was rolled over.  So the loan balance was paid to him (i.e., rolled over) in addition to his eligible balance.  After contacting the participant and the IRA company several times explaining that it was an ineligible rollover, nothing has been done.  The participant has not returned the money, the IRA company has not distributed the money (as far as we know), and we are at a point where we need to correct the 1099, restore the account, etc.  Since the extra $10,000 was not eligible to be rolled over, I assume that the 1099 that was issued for the lump sum would need to be corrected to reflect $25,000 instead of $15,000 and will be taxable to the participant (even though it was rolled over), correct?  The plan's assets are in a pooled account, so I assume that the amount (plus earnings), would just go back into the pooled account, correct?  And lastly, which compliance program would you use or would you just self correct?

Thank you so much in advance for your thoughts and opinions.  

[ETA Consulting LLC]

Your fact pattern doesn't add up.  Please clarify whether the loan was a default or an offset.  Please also clarify the exact amount of the check that was rolled over and the entire cash payout (plus withholding).

Here is what I would expect to see under when a $50K account plus a $10K offset is distributed under circumstances similar to yours; assuming the loan was an offset:
First is a $25K check made payable to IRA with a Form 1099 Coded as a "G".
Second would be a check issued to the participant in the amount of $18,000 with a required withholding of $7,000.  Another Form 1099R would be issued for a taxable amount of $35,000 (with withholdings of $7,000, and a code of "7", or "1", or "2"; whichever is applicable).

Good Luck!
 

[Bird]

19 hours ago, Zoey said:

Since the extra $10,000 was not eligible to be rolled over, I assume that the 1099 that was issued for the lump sum would need to be corrected to reflect $25,000 instead of $15,000 and will be taxable to the participant (even though it was rolled over), correct?

Mmm, as noted above, your numbers don't add up although I think I get it.  It seems you need to amend the "cash" 1099-R to $35,000 and that will take care of it.

19 hours ago, Zoey said:

The plan's assets are in a pooled account, so I assume that the amount (plus earnings), would just go back into the pooled account, correct?

Yes.

19 hours ago, Zoey said:

And lastly, which compliance program would you use or would you just self correct?

I think you can "just" self-correct but that could be considered to fall under a compliance program.  Others might know if this fits in a box. 

[Zoey]

Sorry, I may have confused myself trying to generalize the example...lol.

The exact figures are:

1 1099 - $12,842 Code 1L (treated as a distribution)

1 1099 - $25,000 Code 1 (no withholding)

1 1099 - $28,619 Code G

Total = $66,461

But what was liquidated was  the full $66,461 (not taking into account there was an outstanding loan balance). The extra $12,842 ended up getting rolled over to the IRA along with the $28,619.  The 1099's were prepared based on what he was entitled to, but does not take into account the extra $12,842 that he actually received.

[ETA Consulting LLC]

4 hours ago, Zoey said:

1 1099 - $12,842 Code 1L (treated as a distribution)

There is no "L" when you have a distributable event. The loan offset is eligible for rollover.  Heck, even a defaulted loan is eligible for rollover upon a distributable event (it's no longer a deemed distribution.  It becomes an actual distribution).  I'm not saying that he actually rolled it over, but merely saying that I don't see how an "L" could be used for this transaction. 

Good Luck!

[ESOP Guy]

As pointed it sounds like the loan can be rolled over to the IRA so all the plan needs is to get the over payment back.  So if you can get the guy to write a check for the $12,842 (ignoring earnings at this point) from his own bank account (not the IRA) the plan would be good. 

You could then file a corrected 1099-R for the amount that was taxable.

By the way you need to review your procedures if no taxes were withheld on the cash payment to this person.  One of the 4k people can confirm this or not but doesn't the withholding not only have to be on the $25k that was paid in cash but also the $12k related to the taxable loan amount?  So not only was the wrong amount paid in this case but required taxes weren't withheld on 1 or 2 parts of this payment.  It sounds like your firms has some serious systematic issues on how people get paid. 

[ETA Consulting LLC]

I still don't see it.  The first step is to be able to write the explicit fact pattern as it happened without drawing any conclusions.  Part of that fact pattern would have to explain the actual check amounts.

I agree with ESOP Guy (100%) as he's picking up items in your fact pattern that I missed (since I tend to get thrown off after reading the first line).  Let's try this for a fact pattern.
You're saying:
Participant had $53,619.00 plus an outstanding loan of $12,842.00 in his account.  At payout, he was issued a check for $25,000 (with no withholding) and another check in the amount of $41,461.00 was made payable to his IRA in the form of a direct rollover.

In the meantime, there are various possibilities on what should've happened because we don't know the elections of the participant with respect to rollover amount.  It could've been a direct rollover of $41,461 to the IRA and a cash distribution of $12,158 for which $5,000 should've been withheld.  This would explain your perception that $25K in cash was received since $12,158 was all the cash that was actually left (plus the loan offset of $12,842) would equal $25K.  The only issue, then, would be the fact that you missed the $5K withholding on this $25,000 taxable distribution.

Your firm may actually have it right.  Then again, they may not.  Your fact pattern is missing details and you appear to be jumping to conclusions trying to fill those details in :-) 

Good Luck!

[Zoey]

ESOP Guy, this isn't "our" procedure.  It is the investment company's procedure.  They will not do federal withholding.  They will only issue the check to the participant or another plan or IRA.    

I agree that all would be good if he just wrote a check to the plan, but the trustee has tried and tried to get the money back to no avail.  The terminated participant refuses to pay it back.  The IRA company refuses to distribute it.

[Zoey]

ETA...correct...The actual check amounts were $41,461 to the IRA and $25,000 in cash to the participant...for a total of $66,461.   The 1099's that were issued were $28,619 rollover, $25,000 cash and $12,842 loan treated as a distribution.  (The rollover 1099 being short by $12,842 from what he actually received.)

His total vested account balance was $53,619 plus an outstanding loan balance of $12,842 to get to the total of $66,461.  The checks totaled $66,461.   They should have totaled $53,619...since the loan was payable upon termination and not paid back.  So he received the loan twice so to speak...once when he took the loan (leaving an outstanding loan balance) and again when he received the rollover check.

I hope this explains it better, but if not let me know.

Thanks.

[RatherBeGolfing]

22 minutes ago, Zoey said:

ESOP Guy, this isn't "our" procedure.  It is the investment company's procedure.  They will not do federal withholding.  They will only issue the check to the participant or another plan or IRA.    

I agree that all would be good if he just wrote a check to the plan, but the trustee has tried and tried to get the money back to no avail.  The terminated participant refuses to pay it back.  The IRA company refuses to distribute it.

IF he was over paid, the trustees of the plan have a duty to make the plan whole.  If they can't get the money from the participant, and IRA refuses to distribute it (which isn't surprising since I still don't think we have been given a clear understanding of what happened, and if I was the IRA I wouldn't release any funds either), that leaves the trustee or the sponsor on the hook for the money or to go after a service provider if that is where the problem came from.

As for the deposit of withholding, it is not the duty of the investment company, it is the duty of the PLAN.  If the investment company wont do it (they rarely do), the plan needs to find a service provider who will.  You can't pass the buck by saying its lack of procedure with the investment company.  If the plan relies on an outside consultant like a TPA for admin and compliance, that firm needs to look at their procedures or at least tell the client what the law requires and tell them why it is not being followed so they can make a decision on whether to proceed with their current service providers or look for new ones.

BTW, the withholding party (plan administrator) is liable for the collection and deposit of taxes.  This means that if you fail to withhold and deposit the taxes, and the IRS cannot collect the taxes from the participant, the IRS can recover from the withholding party... Something to consider 

[Zoey]

Thanks Bird!  Sorry, I forgot to thank you for your response. 

And thank you to everyone else too.

[Bird]

I think your numbers are clear enough.  If you're not going to get the money back from the participant, and someone else is going to restore the money to the plan, you just amend the cash 1099-R from 25,000 to 37,842.  I believe the IRS will eventually get wind of the excess rollover b/c that 1099 will be for 28,619 and the form the IRA sends to the IRS showing money received (Form 5498 I think?) will show 41,461.  I'm not sure if they will do anything about it...pretty sure if amounts reported received are less than the 1099 they will inquire.

As far as no withholding, it's not acceptable that it is the investment company's procedure.  Someone has to figure out a way around that for the future, including getting another investment company.

[Zoey]

Thank you Bird!  I didn't know how to explain it any better.  I'm glad you "got it".  I agree that the investment company is crap, and I have explained that to them.  There are very few investment companies that won't do withholding, and even most will at least issue a check made payable to the DOT, even if they send it to the plan sponsor or TPA.  We tried having the investment company issue 2 checks (one for the net and one for the withholding) and the participant ended up cashing  them both.  We are trying to figure something out, but when they won't issue a check to anyone else, what are we to do?  It's not like the sponsor or TPA should send in the withholding, when they can't collect it from the plan (withdrawal).  I would so like to convince them to go to a different platform, but they like that it's cheap and we know why.

[RatherBeGolfing]

5 minutes ago, Zoey said:

It's not like the sponsor or TPA should send in the withholding, when they can't collect it from the plan (withdrawal).  I would so like to convince them to go to a different platform, but they like that it's cheap and we know why.

This makes me curious how it is set up with the platform since the PA (commonly the plan sponsor) should make the deposit and it sounds like you are saying the platform wont issue a check to the trustee?  

[Zoey]

Correct, they will not issue a check to the trustee.  It's crazy.  I have tried talking to the financial advisor about switching them to a different provider, but so far it has fallen on deaf ears.

[RatherBeGolfing]

Wow that is very odd for a 401(k) plan. I guess if I'm in your shoes i would just document every conversation and put it in a CYA file.  Im glad none of my clients have found this particular platform 

[Zoey]

I agree...VERY odd!  Oh yes, I do document everything.  Unfortunately I have a couple of plans with this provider (and same financial advisor), but thankfully that's it.

[ETA Consulting LLC]

There are two very distinct events here.  Those two events should always reconcile, but in this instance they do not.  The first event is what actually happened and the second is what is actually reported.  My question would be who is to say that the excess amount was rolled into the IRA as opposed to being distributed to the participant?  This could easily be a situation where the $41K rollover is correct (and merely go underreported) and that they participant received $25K in cash when he should've received only $12K.
If an reporting was actually done on the events as they occurred, then a 1099R for $41,461 would be issued with a Code of "G"; a Form 1099R for $25,000 would be issued with a Code of "1" to reflect the $12,158 cash and $12,842 loan offset, and a 1099Misc would be issued for $12,842 excess which would represent the overpayment to the participant which failed to get returned to the plan (and for which the plan must be made whole).

This would merely be an exact way to report it has a happened; absent the actual election of the participant.  Ideally, you can sync the series of events and report it pursuant to the elections; which would reflect the excess being rolled over (if that were indeed the case).  

Good Luck!

[Zoey]

Thanks ETA...Good point.