ACP Refund Due Right After In-Service

[austin3515]

Participant is taking an in-service distribution from their Match Account "today" (cash out/non-rollover).  As it turns out we are just about to tell the client they failed ACP testing and a refund is required for this very participant.

Can anyone give me a reason why I can't take the position that the in-service distribution covers my ACP refund?  The excess match (and then some) is about to be be removed from the Plan.  I just don't have time to get the ACP test finalized to process it as an ACP refund yet.  The participant has an urgent need for the funds, so no delay availalbe.

I will certainly send a letter saying the amount of the ACP refund was not eligible for rollover.

[BG5150]

1099-R code?

[Tom Poje]

since you indicated it was a non-rollover I think all that happens is you issue 2 1099-Rs

one indicating ACP refund, the other indicating distribution

[austin3515]

What's a 1099-r code got to do with it (don;t get me wrong I do know what you mean)?  For example, often times a participant will close their account, and even roll it over.  That's treated as a timely ADP refund even if they rolled it over.  It seems to me the most important thing is that the money came out.

[austin3515]

Tom - Do you think it really matters in light of my last response?  I'm thiking the RK would not be flexible regarding changing the 1099 coding.

[Tom Poje]

even if the entire balance was rolled out, an ADP or ACP refund is due and the receiving account needs to be fixed (whether it takes place is a different story) I think the one exception is if the plan is terminated and all balances have been paid out.

It could well be it is a moot point if an entire distribution was made.

but, let's suppose the ee is less than age 59 1/2. (and non rollover)

then the distribution is subject to 10% early withdrawal. but the ACP refund isn't. so it would make a difference having 2 1099Rs. I'm not 100% sure it matters if the investment house cuts one or 2 checks, though it certainly is cleaner if 2 were cut.

[Lou S.]

Well his in-service distribution might have been eligible for rollover and he might very well have rolled it over within 60 days but the ACP refund is not eligible for rollover. If he has funds in his account tyo cover the ACP refund  I don't see why you don't just issue the refund. If the In-service drained his account to the point where it no longer covers the refund than yeah you need to send him a letter indicating a portion of his in-service in not eligible for rollover and recharacterize his in-service as part in-service and part ACP refund.

[austin3515]

1)  Tom P. He was over 59 1/2 so no 10% penalty tax.

2) Lou S. The reason I don't want to do that is the obvious one. It's a pain.  Not a pain for me, but a pain for the executive of a big client.

And where in the regs does it say a distriubtion to a participant only counts as an ACP refund if it's coded a certain way on the 1099?

[Belgarath]

If I understand what you are saying: suppose ACP refund is $5,000, and he is withdrawing $10,000. The entire $10,000 is going to be coded as an eligible rollover distribution, and you are going to withhold $2,000 in taxes, (even though 20% withholding not required on the ACP refund amount) and consider the ACP refund requirement satisfied? Seems doable...

P.S. - is this an audited plan? Auditor might have a problem with it. As to the IRS, I have a hard time seeing why IRS would care - it is taxable either way, and as long as he doesn't roll it over, seems like no harm, no foul. I certainly wouldn't recommend this approach as SOP, however.

[C. B. Zeller]

I agree with Lou S.'s point about it needing to be re-coded in order to prevent the participant from using it in a 60-day rollover. Moreover, it should be re-coded so that the corrective distribution reported on the 5500 agrees with the 1099-R. Will it invite an IRS audit if there is a mismatch? Probably not, but if it did, I wouldn't want to be the one explaining to my client why I decided to take that particular shortcut.

You might be able to re-frame the situation to make it more palatable to the client. Explain to them that they failed the test, and participant X has to take a refund, but since he already took a distribution, you can help them avoid needing to make an additional distribution by reclassifying a portion of the distribution he already took. All they need to do is issue a separate 1099-R in January.

[Lou S.]

2 hours ago, austin3515 said:

1)  Tom P. He was over 59 1/2 so no 10% penalty tax.

2) Lou S. The reason I don't want to do that is the obvious one. It's a pain.  Not a pain for me, but a pain for the executive of a big client.

And where in the regs does it say a distriubtion to a participant only counts as an ACP refund if it's coded a certain way on the 1099?

Code 7 is eligible for rollover

Code 8 is not eligible for rollover

[austin3515]

The 1099-R does not make ineligible for rollover.  The fact that it is an ACP refund makes it ineligible for rollover, and he will be notified accordingly that a portion of the ISD is ineligible.

At this point the exercise is academic because you all inspired to be clean my slate for the morning to finalize the refund and discuss with the client.

But it seems to me it ought to work as described with a nice neat letter advising that $X is not eligible for rollover treatment.

[Belgarath]

Well, anything "works" if it is never questioned. While I think it is unlikely to cause a big problem, there are penalties for intentionally filing an incorrect return. https://www.irs.gov/government-entities/federal-state-local-governments/increase-in-information-return-penalties

Anyway, since you now aren't going to do it incorrectly, no worries!

[Luke Bailey]

In theory, austin3515, had their been time, you could have communicated directly with participant or indirectly through plan sponsor and asked him/her whether he/she wanted to reduce amount of in-service request in light of information that was going to receive $X on account of ACP failure.

[austin3515]

Right but the initial issue was I did not believe time would permit that.  Here's another argument in support of my position.  Let's in January the guy cashed out 100% of his account.  No rollover, just taxable distribution.  I'm sure we all agree the refund requirement would be satisfied. 

Or better yet, let's say he had a $100,000 account, and distributed it all 100% as a taxable distriubtion, and left just $1,000 in his account.  Now here comes another ACP refund of $2,000.  What do you do?  Tell him he needs to take another $1,000?

that just seems crazy, and if you agree with me, then you agree with my approach above!

[Lou S.]

Doing it wrong because it is expedient and "probably" gets the same result isn't really an excuse. I've got no problem with your recharacterization of the in-service, I'm just trying to figure out why the blow back on getting the reporting correct.

[austin3515]

WEll a) I personally do not hink a 1099 code is what makes it an ACP refund; b) getting some of these recordkeepers to change the 1099-R code might be a challenge.

But to your point, I cannot argue with you that if they are willing to change the code, that should be done.  Only that if they are NOT willing to change the code, that doesn't mean this won;t work.  That's the distinction.  For example, imagien trying to get TIAA-CREF to do this.  Ha!!  That's the funniest thing I've said all week!

[Luke Bailey]

austin3515, I think the underlying legal issue is probably the legal effect of the participant's election. If he had the right to the in-service distribution and requested that, I think IRS would say that is what he needed to get, even if, had he known about the ACP refund, he probably would have elected a smaller in-service. However, if the participant ratifies your treatment, then the legal issue becomes pretty subtle.

[loserson]

On 6/7/2019 at 3:22 PM, austin3515 said:

The 1099-R does not make ineligible for rollover.  The fact that it is an ACP refund makes it ineligible for rollover, and he will be notified accordingly that a portion of the ISD is ineligible.

At this point the exercise is academic because you all inspired to be clean my slate for the morning to finalize the refund and discuss with the client.

But it seems to me it ought to work as described with a nice neat letter advising that $X is not eligible for rollover treatment.

The 1099-R is the only way the IRS can police the treatment of the distributed money.

Simply sending a letter with the correct treatment lets the participant know, but when it comes time to apply it or enforce it, the participant's tax preparer and the IRS would both look to the 1099-R.  It is also likely that the participant might not understand the letter or might not keep the letter with tax documents, especially if it does not arrive in ~January.  If the 1099 is wrong, then they might all treat it incorrectly.