What is penalty for failure of plan to withhold 20% from non-rollover

[Guest TrustMe401k]

We have a client who uses self directed brokerage accounts. In the infinite wisdom of the client, he (owner of the company) started transferring assets from the qualified plan brokerage account to his personal taxable account. These were done by the same brokerage firm so they simply journaled the $ from his plan account to his personal account. Problem is that he did not tell us he was doing this and consequently no withholding was done. And also no 1099.

What is the penalty for not withholding? He did include the income on his taxes so he did pay all taxes due. Do we have a major issue here? (besides the issue of a client doing what he pleases without asking/informing us)

Thanks

[Mary Kay Foss]

Withholding applies to the entire distribution but is limited to the liquid assets. If only securities were transferred there is probably no funds to withhold from. Check Reg. Sec. 31.3405©-1 which came out in 1995.

The penalties for not filing Form 1099-R are the ones you should worry about first.

[david rigby]

I wonder if there was a distributable event.

[Guest GregSelf]

I agree with PAX. It sure seems like you've got a lot more than a withholding issue to worry about. Sounds like (1) no distributable event, (2) he's an HCE/fiduciary/party in interest, (3) reversion issue?, (4) probably 5 other things I'm not thinking about....

[david rigby]

You might get beyond the issues of distributable event if

(1) the EE is over NRA, and

(2) the plan permits in-service distribtions to those over NRA.

[Guest mo again]

Mary Kay, I'm not sure I agree with this interpretation of the withholding regs. I believe the only exception is for employer securities, not just any securities. Am I missing something?

[Kirk Maldonado]

I'm not sure that I agree with the statement by Mary Kay Foss "The penalties for not filing Form 1099-R are the ones you should worry about first."

It seems to me that if there is a failure to withhold taxes, there probably is a penalty more severe than the penalty for the failure to file a Form 1099-R. My understanding is that, at least in some situations, if the employer does not withhold the tax (at the time of payment) and the employee does not actually pay the tax (e.g., on April 15th), the employer is liable for the amount of that tax.

[Alan Simpson]

There should be no problem regarding the 20% withholding since according to the initial question "He did include the income on his taxes so he did pay all taxes due". This makes the 20% withholding a mute point.

Therefore, the outstanding problems are:

1. Was there a distributable event (i.e. distribution after NRA, in-service withdrawal, etc.)? If not then the plan needs to go through a corrections process.

2. According to the original question there was no 1099 issued for the distributions. How did the client include the "distributions" as income? I believe that a 1099-R should be issued for the distributions even though it is filed late and the client may need to file a corrected tax return. This may also necessitate a corrected 5500.

3. If a premature distribution penalty is due (10% penalty), was that paid? I would guess so based upon the statement that “he did pay all taxes due.”

4. What procedures have been put into place to ensure that this scenario does not happen again?

In response to Mary Kay and the requirement for withholding, I agree with you. But then again, this is a mute point since the client has paid the taxes.

[Guest]

The failure to withhold is not a "mute" point. There is still a failure to deposit penalty for failure to withhold, plus interest and possibly penalties. There is no free pass simply because the employee ended up paying the tax. The government wants its money when the employee gets his hands on the income (at distribution in this case) not when the employee eventually pays his taxes (presumably, April 15th of the following year).

That said, I agree that the failure to withhold is the least of the problems here . . .

[Alan Simpson]

Okay, I do agree that there could be a penalty for failing to deposit taxes when due (IRC 6656). However, IRC 6656 says “In the case of any failure by any person to deposit (as required by this title or by regulations of the Secretary under this title) on the date prescribed therefore any amount of tax imposed by this title in such government depository as is authorized under section 6302© to receive such deposit, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be imposed upon such person a penalty equal to the applicable percentage of the amount of the underpayment.”

However, basically for the penalties to apply there has to be a willful neglect to pay them. I think there would be a strong argument that this was not willful neglect but just good ol’ “stupidity”. There may be interest due on the taxes that should have been paid, but I think the penalties could be avoided.

That being said, I stand by my original posting.