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Penalty for overcontribution to 401k

Technical topics regarding tax preparation.
#1
swgordon  
I have a client that overcontributed to his 401k in 2017 due to a job change. It was not caught before 3/15 so neither employer will fix the issue as they do not have time. I know this must be added to income for 2017 and then the client will be taxed again once the funds are distributed. It appears that the 6% penalty for overcontribution only applies to IRA and not 401k. Is that correct? If so and the client lets the funds grow tax deferred for the next 30 years there really should not be any negative consequences.
 

#2
novacpa  
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IRC Section 72(t) imposes a 10% additional tax for distributions that don't meet an exception, such as death, disability or attainment of age 59 ½, among others. To avoid this additional tax, correct excess deferrals no later than April 15 of the following year. If you don't correct by April 15, you may still correct this mistake under EPCRS; however, it won’t relieve any Section 72(t) tax resulting from the mistake.

Under Revenue Procedure 2016-51, Appendix A, section .04, the permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable both in the year of deferral and in the year distributed. These amounts are reported on Forms 1099-R. These amounts are reported on Forms 1099-R. In the case of amounts designated as Roth contributions, the excess deferral will already have been reported in income in the year of deferral. However, the amount will be reported as taxable in the year distributed.
 

#3
swgordon  
Thanks but I am not talking about the 10% penalty for early distributions. I am asking whether the 6% penalty for overcontribution (excess salary deferrals) applies to a 401k or if that is only for IRAs. I see no mention of 401k on form 5329. It only mentions IRA, HSA, etc..

If the 6% penalty does not apply then there seems to be no reason why he can't just leave the funds in the 401k until retirement. He will pick up the income on the excess deferral in 2017 and then be taxed again once he distributes it in 30 years.
 

#4
Doug M  
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Your client goes to the 401k custodian. He needs to start the action to get the excess withdrawn.

Corrective distribution has to be made by Tuesday, or lots of ugly stuff starts to happen.

This has been known since 3/15? ER has no control over this.

https://www.irs.gov/retirement-plans/co ... -401k-plan


The amount of the excess deferral will not be taxed twice if a corrective distribution is made. See IRC Section 402(g)(2). The corrective distribution must include the amount of the excess deferrals, along with amounts earned on the excess deferrals during the calendar year during which the deferrals are made without regard to income earned during the “gap period” between the close of calendar year in which the excess contribution was made and the time of actual corrective distribution. See IRC Section 402(g)(2)(A)(ii). Additionally, the corrective distribution must be made be made no later than April 15th following the close of the calendar year during which the excess deferral was made. See IRC Section 402(g)(2)(A)(ii). For example, excess deferrals made during 2016 must be distributed by April 15, 2017. This April 15th deadline is not postponed by extending the filing of the employee's federal income tax return.
 

#5
swgordon  
He contacted both employers last week. They both told him that they could not make a corrective distribution because he would have had to notify them prior to 3/15. They are both very large companies so the process takes several weeks apparently.

I read that IRS link you posted. Based on what I read if the corrective distribution is not made by 4/15, which it will not be, then the funds must be left in the plan and the taxpayer will be taxed when he pulls them out either at retirement age or if the plan fails testing and is forced to make a corrective distribution. There are 2 companies here so i do not believe that they will fail testing as there was no overcontribution to either plan individually. Based on this, I believe that aside from being taxed twice there is absolutely no negative impact to the taxpayer.

From the link: To the extent that a corrective distribution is not made within the correction period, the excess deferrals may not be distributed until a distribution is otherwise permissible under the terms of the plan, or the distribution is necessary to avoid plan disqualification under IRC Section 401(a)(30).

My worry was whether there were any penalties for leaving the funds in the plan. It appears the 6% penalty only applies to IRA and not 401k but that is what I am unclear about.
 

#6
Doug M  
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Learn something new every day. I always assumed the taxpayer would get the monies paid directly to him from the custodian.
 

#7
JAD  
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Are you saying that there is no risk of disqualification/no potential problems because there are two 401(k) plans? If that were the case, everyone would structure their affairs to have multiple employment arrangements with maximum 401(k) deferrals. That is too good to be true. If you have a relationship with a retirement plan specialist, then now is the time to reach out. I agree with Doug - if you don't fix this by Tuesday, many bad things happen. And now that you have touched it, you could be dirty. You need to protect yourself in addition to addressing these issues.
 

#8
WEISSEA  
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It appears the 6% penalty only applies to IRA and not 401k but that is what I am unclear about.
10% for qualified plans. There is a Form for paying the penalty.
 

#9
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My worry was whether there were any penalties for leaving the funds in the plan.

No, there’s no penalties. Nothing to worry about with that. In these multi-employer situations, we do try to get the excess withdrawn by 4/15/Year2. If that doesn’t happen, oh well. Your client just ends up paying tax on the excess twice. My experience is that a real good HR Department at Newco will ensure that this doesn’t happen, by asking the new hire about old job 401k deferrals.

And I totally disagree with Doug/JAD about a lot of bad things will happen. And I especially disagree with every single sentence in JAD’s highly dramatic Post #7
 

#10
swgordon  
Jeff thanks, that is what I believe after researching this today. I can not find anything related to any 10% penalty for overcontribution. The 10% penalty is for early distribution. If there is no distribution then no penalty.

Weissea, if you have a link for that I would love to see it as I have searched and searched with no luck.

And JAD what do i have to worry about? I told the client about it and told him he needed to w/d the funds by 4/17. He then called his benefits departments of both companies and they told him it was too late. They both had 3/15 deadlines. I also told him that he should try and reach out directly to the custodian to ensure nothing can be done before Tuesday, per Doug's comments above. I am adding the overcontribution to wages on the 2017 return so i am doing what I need to do. It is up to the client whether he wants to pursue it any further.
 

#11
JAD  
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A CPA I know well just went through something like this. I don't know all of the details except that there was a 401(k) and a 403(b), excess deferrals, and she got pulled into the problem, wound up doing a bunch of amended returns for free, and her liability insurance had to kick in some of the remedy to the client. I don't pretend to know this area of the law. When there is a question, I call one of the two companies who I work with and talk to people who specialize in this area. What I would be afraid of is what I don't know.
 

#12
Doug M  
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I totally disagree with Doug/JAD about a lot of bad things will happen


No problem. But, I will still stand behind my comment.

*Double tax
*Some plans require that the excess be distributed, or possible plan disqualification. That can be ugly.

Back to the OP. I thought there was this rule that if it was distributed by 3/15, its taxable in 2017. If it is after that date, then taxable in 2018
 

#13
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*Double tax

We already agreed that would be the case.
*Some plans require that the excess be distributed, or possible plan disqualification. That can be ugly.


Well, tell us, which plan would face disqualification, given that neither violated any rule?

What I would be afraid of is what I don't know.


If you don’t know, then stop writing dramatic and alarming posts that are intended to scare swgordon in to taking some action that he’s not required to take.
 

#14
JAD  
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Jeff, you are not the speech police. Why are you telling people what to say and not say?
 

#15
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Why are you telling people what to say and not say?


Sounds like you’re telling me what to not say…

In any case, in your Post #7, you make comments like:

“Now is the time to reach out” and

“If you don’t fix this by Tuesday, man bad things happen” and

“You could be dirty” and

“You need to protect yourself”

These are not comments prefaced with any uncertainty. Yet, later on, in your Post #11, we learn that your comments are based on quite a bit of uncertainty:

Your CPA friend going through “something like this;” and

“I don’t know all the details;” and

“What I would be afraid of is what I don’t know”

This high level of uncertainty was not displayed in your Post #7.

So, to answer your question, why is Jeff-Ohio telling people what to say and not to say? Here’s why: Because it’s the last few days of tax season, when practitioners do not have a lot of time to act, and your alarming comments, which are all wrong, might be distressing to someone who doesn’t know any better and might take them to be true. Or, they might at least might cause that person to dig into a bunch of unnecessary research, or unnecessarily phone a colleague, to determine the veracity of your comments.

Jeff, you are not the speech police.


Sure I am. Everyone is. I am not personally attacking you, at all. Personal attacks are the only thing prohibited on this site. If it was me, and I wasn’t sure, I would say as much before commenting. But again, that’s just me.
 

#16
JAD  
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If I were in his situation, and someone on the board knew that there could be issues, then I would want the feedback that I provided. Especially near the deadline, when a tired, busy person might not be looking as closely as he should. My friend's experience certainly would impact the way that I would approach this situation. And you are wrong, we are not all the speech police.
 

#17
Doug M  
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Well, tell us, which plan would face disqualification, given that neither violated any rule?


So, the IRS says the money stays in the plan, the penalty is double taxation. But, what happens when a plan document states these excess amounts must be distributed. That is my point. But, I think we have hashed this out more than needed.

And based upon your next post, I guess not.
Last edited by Doug M on 16-Apr-2018 3:26pm, edited 2 times in total.
 

#18
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And you are wrong, we are not all the speech police.


Just point to the Site Guideline that says that and I’ll agree with you…

If I were in his situation, and someone on the board knew that there could be issues


No one on the board “knew” there could be issues, including yourself, because there are no issues, at least with respect to the ones you suggest…

when a tired, busy person might not be looking as closely as he should.

Right, or when a tired/busy person bases comments on a different fact pattern, instead of the simple/common one involving a W2 employee that changed jobs.
 

#19
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But, what happens when a plan document states these excess amounts must be distributed. That is my point.


There is no excess amount from a plan operation standpoint. See Sec 401(a)(30). There is nothing tax-code-operationally-wrong with either plan when each plan has accepted EE 401k deferrals that are under the 402(g) limit.

The language in 402(g)(2)(A)(ii) is permissive, not mandatory:

not later than the 1st April 15 following the close of the taxable year, each such plan may distribute to the individual the amount allocated to it under clause (i) (and any income allocable to such amount through the end of such taxable year).

But, arguendo, let’s say the plan says: “The plan MUST distribute the excess once properly/timely notified by the EE.” If the plan fails to act on time, it’s still not a tax code operational failure that would cause plan disqualification because 401(a)(30) still hasn’t been violated. In that case, if the employee has a beef, then he can go sue the plan administrator if he feels like it.
 

#20
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I am glad to find this old thread, it answered the same question I have. By adding a new question related to the topic and a clarification issue, I hope to make this thread more complete for other people to search in the future.

My question is about the situation where the over contribution ends up with a loss. For the ease of discussion, let us say the over contribution is 1000 in year Y, and the loss is (50) in the year of distribution.

In a timely distribution in year Y+1 before the deadline, the income to add in year Y will still be 1000 instead of 950 because if there was no over contribution the taxable income would be 1000? In year Y+1, how would the 50 loss and 1000 basis be reported? The form 1099-R cannot report a loss, and form 8606 is for IRA. The loss will go to the miscellaneous deduction that The Tax Cuts and Jobs Act eliminated?

Suppose the over contribution is distributed after the deadline, then the 1099-R would report a taxable distribution 950 instead of 1000 because that is what gets actually distributed?

My clarification issue was:

Back to the OP. I thought there was this rule that if it was distributed by 3/15, its taxable in 2017. If it is after that date, then taxable in 2018

I do not find such a rule, because it is said "Earnings are taxable in the year they're distributed" ( https://www.irs.gov/retirement-plans/40 ... istributed ), just want to confirm to make this thread complete in information. Thanks all who participated in this discussion, your voices from 2018 are heard today in 2021.
Please consider visiting this post where my question at the end has not been answered yet:
viewtopic.php?f=8&t=12065, thanks!
 


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