Penalty for faliure to withhold taxes

Participant in plan that has brokerage accounts took a distribution of all her funds in 2019.  We are just finding out about this like last week.

She took the money to herself and there was no withholding.

Is there a penalty for not withholding?  How does it get assessed?

I know there's gonna be a late fee for the tardy 1099-R.

I can't cite anything off the top of my head but it is my understanding is if the person doesn't pay the taxes the IRS can come after the Plan Sponsor for the taxes still.   Once the taxpayer pays the correct taxes the plan and sponsor are pretty much off the hook.  

Rather than the sponsor being on the hook for the "correct taxes", it might be on the hook for the 20% default withholding.

Section 6651 imposes a penalty on the payor or plan administrator of 5% per month until tax that should have been withheld is paid, capping out at 25% at 5 months, of amount of tax that should have been withheld. Additionally, the payor or plan administrator is liable if the distributee ultimately does not pay. As to how they catch you, Form 3405, unlike 3401, does not require that you show the total amount of distributions paid, just the tax you withheld. It may be that they would first need to go after the payee based on the computer check of the 1099-R, and then work back from there. I have not dealt with this for retirement plans, but in somewhat similar situations with stock options (employer treated non-ISOs as ISOs), it can be a mess to fix. The only simple way is to have the distributee voluntarily return the funds to you and then file a corrected 945 or a 945-X. I believe there is a way to claim credit if the distributee pays, but it's complicated.

Doesn't the custodian of plan assets have some liability here?  After all, the money appears to have been distributed without approval from the plan administrator or the plan trustee.

2 hours ago, M Norton said:

Doesn't the custodian of plan assets have some liability here?  After all, the money appears to have been distributed without approval from the plan administrator or the plan trustee.

M Norton, that is definitely a possibility. Note that the Code says the obligation is on the "payor," but then shifts it to the "plan administrator" in the case of a 401(a) plan unless the plan administrator has both directed the payor to withhold and provided it with information needed to withhold. See Section 3405(d)(1). You would need to review the agreements and course of conduct between the parties.

14 hours ago, M Norton said:

Doesn't the custodian of plan assets have some liability here?  After all, the money appears to have been distributed without approval from the plan administrator or the plan trustee.

I believe the PA/Trustee approved the distribution.

They just didn't inform us until way late.

Not much will happen if the recipient pays the tax directly.  Yes, 20% is required but there are no direct penalties (I'm not sure Sec 6651 applies).  The participant could say the sponsor is liable (true) but then the sponsor would have an equal claim against the participant.  A good scolding is in order, and you might want to consider whether you should(n't) be getting copies of statements directly rather than relying on someone sending them (much) later.