Excess SEP Contribution Returned

[Helen]

I have an S-corp (single shareholder) which made an excess employer SEP contribution in 2014. It was discovered prior to the due date of the return and a refund of the excess was requested. The excess contribution was recorded as a receivable on the corp’s books as of 12/31/14. No expense deduction was claimed by the corp in 2014 for the excess.

I’m not sure what options the client had for the refund, but rather than returning the excess and earnings to the employer, the funds were returned to the client personally. Client deposited refunded monies to the S-corp and did not retain any personally. Client receives a 2015 1099-R under his SSN, showing the return of the excess contribution and earnings in Box 1 and showing ALL as taxable in Box 2, codes 8 and 1.

Since all of the excess refund was deposited into the S-corp, there should be no taxable consequence to him individually.

Any advice on how best to report this would be appreciated. Report the 1099-R but enter zero as the taxable amount, even though it will not match with the 1099-R received by the IRS. Ask the brokerage house to correct the 1099-R? Any other suggestions?

[Roland Slugg]

Hello Helen. The situation was handled incorrectly, and I believe your client is stuck for the tax on that distribution, plus the 10% penalty if he was under age 59½ at the time.

If an employer's contribution to a employee's SEP exceeds the deductible limit, the excess can be carried over to, and deducted in, succeeding tax years in order of time. (Code §404(h))

There is no provision to return excess contributions to the employer. Once the contribution arrived in the employee's IRA, it was his, and any subsequent distributions from that IRA to him are treated in accordance with the usual distributions rules.

It's a shame this happened. It would have been so easy to look up the proper treatment before action was taken.