Non-taxable contributions in the 1099R/EPCRS correction

[With Appreciation....]

We are the TPA. Just discovered that for several years retired participants have received incorrect 1099Rs. Specifically, the 1099Rs have included non-taxable contributions in the amounts reported.

For some, the 1099Rs have been incorrect for at least 10 years.

There are at least two immediate concerns:

How far back is necessary for providing corrected 1099Rs for amended tax purposes?

What is the EPCRS VCP-correction method which would be acceptable to return after-tax credits to the affected participants? (I’ve scrutinized EPCRS but can’t locate the applicable section)

With thanks,

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

[ETA Consulting LLC]

I don't think this could be corrected under VCP; as it really doesn't amount to an operational failure of the plan.  Instead, it involves a failure of the payer to properly report the distributions. 

Good Luck!

[With Appreciation....]

Thank you for your response.

As a follow-up question: Because of the failure to properly report the distributions the participants paid an excess of taxes and are entitled to a refund.

Because, however, the 3 year period for filing amended returns has passed, and the participants can no longer receive refunds from the IRS, the plan sponsor will make the participants whole. Can this, then, be done as lump sums by the plan sponsor to participants, because 1) distributions have already been made from the trust assets and 2) the corrective amounts are reimbursements for incorrect taxation, rather than incorrect distributions.

I think so, but would be grateful for any thoughts or guidance on the best way to make this type of correction.

 

 

[ETA Consulting LLC]

The first step would be the measure the impact of each participant.  Then, any reasonable approach may be done at the participant level.  If one participant had taken a distribution and no basis amounts were determined, then you can apply the basis amounts on prospective distributions.  If another participant had taken all his distributions, then that would warrant a different method.  Whatever you decide, just be sure to document it (as to know exactly what was done and why in the event it's looked at again years from now).

Good Luck!

[AMDG]

ETA Consulting - What Code section are you relying upon for your answer?  The distribution amount was reported incorrectly, but that does not change either the basis recovery rules or the taxable and nontaxable amounts that were actually distributed. 

The solution is to recreate the account balances at the time of each distribution, and determine what the correct reporting should have been.  Corrected 1099-Rs can be generated for open tax years.  As "With Appreciation" implies, someone else may need to make the participants whole for excess taxes paid in the closed tax years.

[Larry Starr]

2 hours ago, ETA Consulting LLC said:

The first step would be the measure the impact of each participant.  Then, any reasonable approach may be done at the participant level.  If one participant had taken a distribution and no basis amounts were determined, then you can apply the basis amounts on prospective distributions.  If another participant had taken all his distributions, then that would warrant a different method.  Whatever you decide, just be sure to document it (as to know exactly what was done and why in the event it's looked at again years from now).

Good Luck!

I agree with AMDG that you cannot change the rules on reporting basis because the prior 1099s were wrong.  You  need to figure out what the current amounts should be AS IF the prior 1099s were correct (even though they weren't); produce corrected 1099s for 3 years, and then if the employer is so inclined, cut a check to the participants for "feel good" purposes to try to make up for the error.  Some effort will have to go into figuring out how much that "feel good" amount should be, and it may not be deductible (or may) at the business level and it may (or may not) be taxable at the participant level (my head hurts just thinking about those issues, but someone is going to have to deal with that if "feel good" payments are made.

 

[Luke Bailey]

The IRS has a correction program outside of EPCRS for problems/errors like this, which do not involve plan qualification. Go to this web page: https://www.irs.gov/retirement-plans/employee-plans-voluntary-closing-agreements and check it out. Then you will probably want to call Paul Hogan or Thelma Diaz and explain your facts without divulging identity of clients. Closed years present difficult correction issues. There may be a way to get the "make whole" money into a qualified plan or IRA, but will be complicated with basis issues, etc. For those who rolled over, the transferee vehicles may have to provide basis, and they will hate that.

[ETA Consulting LLC]

If you have $10,000 in an account comprising $5,000 in basis and $5,000 in gains; and have taken $5,000 in distributions over the years for which no after-tax basis amounts were recognized; I would like to hear an argument as to why the $5,000 in basis would not still remain in the account.  To me, it's simple math.  Regardless of what should've happened, that basis  remains until it's utilized.

Good Luck!

[Luke Bailey]

 

16 hours ago, ETA Consulting LLC said:

If you have $10,000 in an account comprising $5,000 in basis and $5,000 in gains; and have taken $5,000 in distributions over the years for which no after-tax basis amounts were recognized; I would like to hear an argument as to why the $5,000 in basis would not still remain in the account.  To me, it's simple math.  Regardless of what should've happened, that basis  remains until it's utilized. 

Good Luck! 

I think in theory the IRS would apply the basis recovery rules under Section 72 and you could have had some of the basis already coming out, it was just not reported.

[Larry Starr]

18 hours ago, ETA Consulting LLC said:

If you have $10,000 in an account comprising $5,000 in basis and $5,000 in gains; and have taken $5,000 in distributions over the years for which no after-tax basis amounts were recognized; I would like to hear an argument as to why the $5,000 in basis would not still remain in the account.  To me, it's simple math.  Regardless of what should've happened, that basis  remains until it's utilized.

Good Luck!

But that that were the case; the IRS will apply the rules in existence. There is no "rule of logic" which I admit you are suggesting, but it just doesn't exist.