402(g) excess discovered after 4/15 in off-calendar year plan

[415 Limit]

Plan year runs from 7/1 to 6/30.

During calendar year 2017 a 44 year old participant deferred $18,000 pre-tax 401(k) plus $4,500 Roth 401(k) (total = $22,500, see breakdown below).  The famous payroll company neglected to report the Roth deferrals in box 12 of the W-2 (AA) so this was not caught until after 4/15.

Between 1/1/2017 - 6/30/2017: $5,200 pre-tax 401(k) plus $3,900 Roth 401(k) (total = $9,100)

Between 7/1/2017 - 12/31/2017: $12,800 pre-tax 401(k) plus $600 Roth 401(k) (total = $13,400)

Are we permitted to distribute the $4,500 in excess deferrals from Roth?  Is it relevant that all but $600 in Roth deferrals were made during the prior fiscal year (6/30/2017)?

Thanks for any input.

[Luke Bailey]

The taxable year referred to in Section 402(g) is the taxable year of the participant (invariably, the calendar year), not the plan year, where the plan year is other than the calendar year. I don't believe there is any exception to the April 15 deadline in IRC sec. 402(g)(2)(A)(ii), so the excess deferral would need to stay in the plan until the individual otherwise has a distributable event.

When the excess deferral is eventually distributed, then to the extent it is attributable to the pre-tax elective deferrals, it will be taxed again. The second tax can be postponed (but may be greater, because of earnings) if the amount is rolled over. To the extent the excess deferral, when eventually distributed, is attributable to the Roth contributions, it will not be eligible for rollover and will be taxed again, even though contributed as Roth. See Code sec. 402A(d)(3).

I am unaware of any guidance on how to determine, in a case such as you have posited, whether the $4,500 is attributable to the Roth or pre-tax deferrals. You may be able to adopt a plan rule that specifies this. Maybe someone else has experience with this issue, but it would seem to me to depend, at least in terms of fairness, on how the IRS Service Center treats this. If when the Service Center gets the corrected W-2 showing total deferrals of $22,500 and Roth of $4,500 the Service Center increases the individual's reported income by only $4,500, they are in essence treating the Roth as the excess. On the other hand, if they include a larger amount in the individual's income, they will be treating all or part of the pre-tax as part of the excess, e.g. if the IRS Service Center treats $9,000 as taxable in making an adjustment to the individual's return, it will be treating the entire $4,500 excess as pre-tax. Maybe this is controllable by the employer in the way reported on the W-2 or W-2(c) and covered in the W-2 instructions, but I think the W-2 instructions avoid the issue. The have an example on page 19 of an excess deferral that is attributable to both Roth and non-Roth, but they assume that the excess is timely distributed.

[RatherBeGolfing]

13 hours ago, Luke Bailey said:

I don't believe there is any exception to the April 15 deadline in IRC sec. 402(g)(2)(A)(ii), so the excess deferral would need to stay in the plan until the individual otherwise has a distributable event.

One argument is that the deferrals can be distributed after  the April 15 deadline if the excess deferrals would cause the plan to violate 401(a)(30).  

[Tom Poje]

under EPCRS, Appendix A

.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.

 

This applies when a plan accepts excess deferrals (to avoid plan disqualification)

If it involves 2 different plans and nether plan accepted excess deferrals then neither plan has a violation, and then the concept of 'you must have a distributable event' kicks in.

..........

when the situation involves Roth it is more complicated. we just went through a discussion

 

The preamble to the regulations on Roth Contributions contains the following note:

 

“Designated Roth Contributions as Excess Deferrals

Even though designated Roth contributions are not excluded from income when contributed, they are treated as elective deferrals for purposes of section 402(g). Thus, to the extent total elective deferrals for the year exceed the section 402(g) limit for the year, the excess amount can be distributed by April 15^th of the year following the year of the excess without adverse tax consequences. However, if such excess deferrals are not distributed by April 15^th of the year following the year of the excess, these proposed regulations would provide that any distribution attributable to an excess deferral that is a designated Roth contribution is includible in gross income (with no exclusion from income for amounts attributable to basis under section 72) and is not eligible for rollover. These regulations would provide that if there are any excess deferrals that are designated Roth contributions that are not corrected prior to April 15^th of the year following the excess, the first amounts distributed from the designated Roth account are treated as distributions of excess deferrals and earnings until the full amount of the those excess deferrals (and attributable earnings) are distributed. “

So as far as I can tell, if the excess deferrals occurred in two unrelated plans (and neither plan was required to make a distribution) any excess amount should be segregated from the other Roth contributions and tracked separately. Thus, the Roth deferrals were taxed when they were made, and eventually when the deferrals are withdrawn, they pay taxes again, including the earnings. If the excess Roth deferrals were not segregated, the individual would receive the windfall of the  earnings being tax-free, certainly not something intended under the regulations!

 

[Luke Bailey]

A few points. First, 415 Limit, take note that RatherBeGolfing and Tom Poje have correctly and importantly corrected me that since, in your case, the excess deferrals are attributable to contributions to a single plan, they can be distributed after April 15, and should be, per EPCRS self-correction. However, the double taxation penalty on the participant will not be avoided.

Second, I agree completely with Tom Poje's statement that that if the Roth excess deferrals occurred under a single plan, they need to be segregated into a separate account with tax characteristics unique to excess deferrals attributable to Roth contributions. The tax treatment of that segregated account is unique, however, in that (a) the amount is treated as pre-tax, and thus the original contribution amount and earnings are includible in the participant's gross income when distributed following a distributable event, but (b) they do not qualify for rollover under Treas. reg. 1.402(g)-1(e)(8)(iv).

I'm still wondering, in a case where the excess deferral is caused by pre-tax and Roth contributions to the plans of two different employers, and the IRS aggregates the deferral amounts on the participant's w-2's and determines the excess, whether the IRS is going to adjust the participant's 1040 based on the assumption that the excess was attributable all to the pre-tax, all to the Roth, or some combination. The employer's accounting for the Roth contributions would seem to need to take that into account.