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Excess Deferral Roth


Brenda Wren

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This is a 2-part question.  Was the deadline to distribute excess deferrals postponed to May 17 this year?   Secondly, suppose an employee participated in two 401(k) plans during 2020 (unrelated employers) and funded $19,500 in Roth deferrals to both plans.  (Yes, this is a true case!)  Is there a remedy for this error or should we ALL be trying to do this???  The penalty of "double taxation" doesn't apply, so what does??

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You can only contribute 19,500 and catch up, the limit is the same no matter how many companies you work for. To answer your question, I have not herd that it was postponed to May. But maybe someone else will chime in. 

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1. No, that deadline was not extended.

2. The IRS will notice the excess deferral and when it is distributed after the deadline, my understanding is that it will be treated as taxable, including its earnings, and not rollover eligible, regardless of having been deferred as Roth. So, double taxation is still the “penalty”.

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Deadline not extended, 2 unrelated plans, too late to remove the funds.  There is no provision in the plans to remove the funds after the deadline since they are unrelated employers.  What IRS will see is that $39,000 was contributed on the W-2's.  But they see similar situations often and the remedy is that the amount over $19,500 is taxed with the 1040 return.  But the Roth was already taxed, so no tax implication on the 1040.  I'm thinking that the best course of action is to do nothing and wait to see what IRS says when the 1040 is filed.  And I'd really like to see the regulation that addresses this situation.  So far, I haven't been able to find anything.

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I had a question come up from a staff member in essentially the same situation a few years back. FWIW, here was my take on the situation:

Code § 402(g)(1)-(2) and Reg. Sec. 1.402(g)-1(e)(2) clarify that, unless timely distributed, excess deferrals are (1) included in participant’s taxable income for the year contributed, and (2) taxed a second time when the deferrals are ultimately distributed from the plan. The excessive deferrals involved in the error were not timely corrected because the April 15 deadline has already passed. Accordingly, the excessive deferrals must be taxed for the 2017 year (i.e. the year contributed) and again when the excessive deferral is distributed from the plan. 

If a corrective distribution is not made within the correction period discussed above, then excess deferral cannot be distributed until either (1) the distribution is otherwise permissible under the terms of the plan, or the distribution is necessary to avoid plan disqualification under Code § 401(a)(30) (note: there is not a plan disqualification issue under Code § 401(a)(30) because the error involves excessive deferrals between two unrelated plans and employers). To elaborate on this point, under Code § 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS. However, in the situation involving the error under discussion, the excess deferral amounts involve two unrelated plans with two separate employers. The IRS has stated on its website that “excess deferrals by a participant will not disqualify a plan if the excess is due to the aggregation of the participant’s deferrals to a plan maintained by an unrelated employer.” Accordingly, the fact that the error involves excessive deferrals among two unrelated plans/employers means that neither plan has experienced a disqualifying event because of the excess deferral. 

Reg. Sec. 1.402(g)-1(e)(8)(iii) allows for distributions of excess deferrals after the correction period to be distributed from 401(k) plan only when permitted under Code § 401(k)(2)(B). As discussed above, plan disqualification is not an issue; accordingly, the excessive deferral can only be distributed if permitted under the terms of the plan (i.e. termination, age 59 1/2, or other Code § 401(k)(2)(B) permissible times).

Is the excess a Roth deferral? (Please say no.) If Roth, it would somehow have to be separately “tracked” so that if ultimately distributed after 5 years/59-1/2 , the excess deferral plus earnings would NOT be a qualified distribution, and would be fully taxable.

I’m not sure the IRS ever fully contemplated this foolishness properly. I’m not sure I can blame them – it is a pretty wacky scenario.

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Both deferrals were Roth.  Recordkeepers are taking the position that at this point, April 20, there is no distributable event (as noted above).  No mechanism in place to "separately track".  Appears that participant will likely suffer no negative consequence and ultimately receive tax-free earnings on 2 deferrals for 2020, UNLESS something results from the filing of the 1040.

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Wow, looks like I chimed in on that thread back in 2018!  Senior moment!  Well, in this case, I am not the TPA for either plan.  So no ethical choice for me to make.  This came to us from a CPA as he was preparing the 1040.

Thanks to all!

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  • 4 weeks later...

Reg. 1.402(g)(e)(8) is clear that if the Roth excess contributions are not distributed by the deadline, they are taxed again when they come out. Double taxation of the contributions. Intended. Single taxation of the earnings, plus you get deferral, so maybe some offset to the negativity of double taxation.

But practically speaking, how does this actually work? First, as others have pointed out from time to time, does the plan with the excess (and which plan is it?) segregate the excess so that it properly reports it as taxable when distributed? How would it know to do that, and where is the guidance telling them to do that, other than the just-cited reg that says in principle it's double-taxed? Moreover, what is the effect on W-2? If Roth, then the contribution did not reduce Box 1. So it's taxed there. When the IRS eventually sees the two W-2's, from two different employers, and then the Service center sends the notice regarding the excess, does it know that it is a Roth excess, or does it just tell the taxpayer they are making an adjustment to their 1040? Presumably the former, since there is a code, AA, for Roth. So the burden  of making the intended scheme work is really on the plan, that may not even know about the problem? Seems like that's the case.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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