Correcting Impermissible Distribution, Successor 401(k) Plan

[PensionPro]

One person 401(k) plan wanted to move investment companies in 2010, was advised he had to terminate plan and adopt a new plan.  Participant was less than 59 1/2 and no distributable event.  Assets were rollover over to IRA and never withdrawn, it is still in the IRA, so apparently no tax consequence.  The new plan is terminating now in 2018.  The owner wants to fix the failure in the first plan.

What is the fix at this point?  Can he ride the statute of limitations and do nothing?  Appreciate any insights!

Prior discussion here:

https://benefitslink.com/boards/index.php?/topic/56188-successor-401k-plans-correction-thoughts/

 

[Bri]

What's the actual problem?  Starting the successor plan too soon?  Plan 1's termination at least provided a distributable event for the rollover.

[PensionPro]

Plan 2 was adopted immediately after termination of plan 1, well within 12 months.

[Kevin C]

The problem is that timing of the adoption of Plan 2 resulted in the termination of Plan 1 not being a distributable event.  See 1.401(k)-1(d)(4).

 

Rev. Proc. 2016-51 6.06 (4) has the pre-approved correction for an overpayment from a DC plan.  The participant can repay the overpayment, adjusted for earnings.  With Plan 1 no longer in existence, I would be inclined to try using the actual return on the IRA as the earnings adjustment.  With the amount of time that has passed, this would fall under VCP.  The Rev Proc is clear that an overpayment is not eligible for rollover. It doesn't specifically say that correcting it by returning the overpayment eliminates the tax consequences, but that would make sense because after a full correction, there should not be an overpayment.  If the rollover amount was substantial, you might want to consider an anonymous VCP filing.  I think I would suggest that the correction is to roll the entire IRA into Plan 2.  That puts the plan and participant back to where they would have been if the error had not occurred.

Audit lottery has it's risks.  Since the overpayment was not eligible for rollover, it should have been taxable in 2010 and was an excess IRA contribution.  That could get nasty.

[PensionPro]

I agree with your approach.  It is a prospective client's plan so we are interested in giving them the correct viable options.  However, I am curious about the application of the statute of limitations.  Is the IRS in a position to audit this plan 1 for the 2010 year?

[Kevin C]

Your OP indicated the owner wanted to fix this, which I took to mean he has already decided to not play audit lottery.  I'd rather not speculate on how likely it is that the IRS would discover this on their own.  While the 2010 year for Plan 1 should be closed, what about the participant's 2010 tax year? Is there a statute of limitations for unreported taxable income?  Does the excess IRA contribution carry forward to later tax years, through and including this year?

[PensionPro]

Great points! I am going to recommend he talk to an ERISA attorney and/or tax advisor.  No point in making a client's problem my problem.  That said, I am always curious about the statute of limitations on these types of transactions.