Excess SEP Contribution Problems

[geekgirldany]

I hoping some of you all can help me with this as it has my head spinning.

Taxpayer had a business from 2013 to 2016. In 2013 he contributed to a SEP IRA for Tax Year 2013. He did not ask his accountant at the time how much to contribute but asked his financial advisor which told him way too much to contribute.

He contributed $18,000 should have been $4,000. So tax time Mar/April 2014 comes accountant tells taxpayer to get the excess out the SEP as it will cause problems with the IRS. For TY 2013 a SEP Deduction of $4,000 was taken... leaving $14,000 excess.

So, from the paperwork I got it appears that the client waited until Dec 2014 to move the excess from the SEP to a Non IRA account. The Bank did move it and generated a 1099-R for 2015... which the client never got I guess as I was doing the tax return then and was not given the 1099-R.

Each year a SEP Contribution was deducted and the money was moved from the Non IRA account into the SEP Account each year 14,15,16.

Taxpayer has now received a notice that the 1099-R was not included on the 2015 tax return, has to pay tax on the amount "withdrawn" Code 1, and 10% penalty.

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From my reading Pub 560, page 7 the non deductible contributions can be carried over but subject to 10% excise tax. Then on page 16 it says there is a special rule for self employed individuals that the 10% penalty does not apply.

I feel the client might have to pay the tax because the excess contributions were not taken out before April 15, 2014 (TY 2013) but in December 2014.

Any thoughts on this as I am very much confused.
Thank you for any help.

[Roland Slugg]

Hello GGD. What you described is an unfortunate situation, but probably not as bad as it may seem. First I will comment on various parts of your post, and then suggest a course of action.

From my reading Pub 560, page 7 the non deductible contributions can be carried over but subject to 10% excise tax. Then on page 16 it says there is a special rule for self employed individuals that the 10% penalty does not apply.

Yes about the carryover, and yes, the 10% excise tax penalty does apply for each year the carried over funds are left in the SEP. The exception for certain self-employed persons does not apply, however, as that exception is only for situations when the excess was due to a minimum funding requirement. That was not likely the case with your client.

The client waited until Dec 2014 to move the excess from the SEP to a Non IRA account. The Bank did move it and generated a 1099-R for 2015

If the excess was removed in 2014, the 1099-R should have been for the year 2014, not 2015. You need to get the facts correct before proceeding. If the funds were actually removed in 2014, the 2015 1099-R form is incorrect (unless there was another distribution in that year as well).

Taxpayer has now received a notice that the ... income reported on the ... 1099-R was not included on the 2015 tax return, has to pay tax on the amount "withdrawn" Code 1, and 10% penalty.

If the amount withdrawn was the excess 2013 contribution, the 1099-R should not have been coded 1, but either 8 or P. Of the amount reported on the 1099-R, only the portion representing earnings was taxable income. The rest is the return of the excess contribution, and that excess was not deducted on the T/P's 2013 T/R.

What is the IRS proposing? Tax on the full amount reported on form 1099-R? Plus 10% early withdrawal penalty? Plus FTP penalty and interest? If the amount reported on the 1099-R was, indeed, simply the amount of excess contributions plus earnings thereon, only the earnings were taxable. The 10% excise tax would also apply, about $1,400, since the excess funds were not removed in time.

What to do?

First, get the facts regarding timing. If the excess was, indeed, removed in 2014, why was a 2015 1099-R issued? Bank error? Or was there another distribution in 2015?

Next, write a letter to the IRS concisely explaining the facts. Don't mention that the T/P didn't receive the 1099-R form. It's irrelevant, and probably not even true. If there were earnings on the $14,000 removed, agree that those earnings were taxable. Request a waiver of the 10% excise tax/penalty. Can't hurt, and the IRS is often quite lenient regarding those penalties. Best outcome: Tax on the earnings (total amount removed, minus ($18,000 - $4,000)). Worst outcome: Tax on the earnings, plus 10% excise tax/penalty on excess contribution for one year. P&I on the tax due, although the IRS might even waive the penalty on the tax.

Once you break it down, the situation really isn't all that complex.

[geekgirldany]

Thank you Roland for responding and breaking it down for me. Making it clearer for me and brings up additional problems.
What has me confused is the date of withdrawal of the contributions as well as the 1099-R issued.

If the excess was removed in 2014, the 1099-R should have been for the year 2014, not 2015. You need to get the facts correct before proceeding. If the funds were actually removed in 2014, the 2015 1099-R form is incorrect (unless there was another distribution in that year as well).

There is a paper signed by the Taxpayer dated December 28, 2014. This is when the excess contributions SHOULD have been removed.

I told the client to get a letter from the bank explaining what happened. The bank letter states the excess contributions were withdrawn in March 2015. The client then sent me account summaries showing the amount withdrawn in March 2015.

I am not sure what happened... if the bank dropped the ball on taking the excess contributions out before the end of the year, caught the error, then removed in March 2015???
The financial advisor told the client he is "on his own" with the IRS Notice and they would not help in anyway.

What is the IRS proposing? Tax on the full amount reported on form 1099-R? Plus 10% early withdrawal penalty? Plus FTP penalty and interest? If the amount reported on the 1099-R was, indeed, simply the amount of excess contributions plus earnings thereon, only the earnings were taxable. The 10% excise tax would also apply, about $1,400, since the excess funds were not removed in time.

Yes the IRS is treating it exactly like a early withdrawal from a retirement account and the amount on the 1099-R is a round figure $14,000. So I do not believe earnings are even reflected.

Should a letter be written as you suggested and "Tax on the earnings, plus 10% excise tax/penalty on excess contribution for one year. P&I on the tax due"?
Or try to make a case showing the signed document dated in 2014 and say the 1099-R for TY 2015 was incorrect.

I am sick right now so hopefully the above makes sense. Thank you for your time.

[Roland Slugg]

From what you've written in your two posts, I have the impression that your client doesn't pay attention to tax matters. December 28, 2014 was a Sunday, so he certainly wasn't in any bank that day handing someone a form or document. Maybe he signed it that day then finally got around to taking it to the bank 2½ months later.

If the 1099-R reports exactly $14,000, that is almost surely wrong, too. In order for that figure to be correct: (1) the original contribution would have to have been exactly $14,000 more than his 2013 SEP deduction, and (2) there were no earnings (or a loss) on the funds during the entire time they were in the SEP account. Possible, but highly unlikely.

Your client probably did receive a form 1099-R, in January 2016, for the year 2015. He just didn't show it to yewwww. He also probably didn't tell the bank what the distribution really was ... removal of an excess contribution. He prolly just said, "I need to take $14,000 out of my SEP-IRA" ... and the bank gave it to him. That means he didn't take out the earnings, either.

Of course, there's always the possibility that neither you nor anyone else clearly and correctly explained everything to him at the time, telling him exactly what to do to fix the problem. Few people would know what to do in that situation without proper advice.

In any case, I suggest you (or someone) write a letter to the IRS, as recommended already. I believe the 10% penalty (excise tax) should only apply for one year. The excess should have been withdrawn by April 15, 2014, so if it was actually removed in March 2015, that's less than one year late. If the IRS is in a generous mood, he might even get a complete pass. If not, consider a first-time penalty abatement request. Not sure if it applies to a situation like this, but you can easily find out, I'm sure.

[geekgirldany]

Thank you for all your help and direction Roland.

Like to give people the benefit of the doubt... the client admitted to me that after the excess contribution problem came up that he just wanted to forget about it. More than likely the bank told him to get the funds out when it was time to contribute again for the SEP. Really don't know what happened. Just hope the IRS accepts the 1 year/10% penalty.

Again thank you for discussing this with me.

[Snaggletooth]

Barbershop and Beautyshop Advice

The financial advisor told the client he is "on his own" with the IRS Notice and they would not help in anyway

At least when you get your hair done the advice is coming from the innocent uninformed who have no agenda. This guy got commissions on a deposit 350% larger than it should have been. And now the client is "on his own?" Sad but true. The broker is working for a financial services company who will take that position and clearly state "please consult your tax professional with any question about your taxes."

Yes he should have. Between this guy and his broker, they really did a bangup job. The IRS is ringing the cash register.

Teluwhut (Alabamese for "Tell You What"): Pay IRS everything they can throw at this guy. Then sue his company in small claims court for the money and see how detached they are.

[FEDUKE404]

Comparable story

This entire scenario reminds me of a (one-time) client who recently contacted me wanting me to return his 2013 W2s etc ASAP and/or go ahead and file his 2013 tax returns since subsequent year tax refunds are being held. Seems the IRS has done their "own" calculations for his unfiled 2013 return.

I pulled his file and he e-filed his 2012 tax returns on October 15, 2013. I have no 2013 tax documents from him, and do not even have a 2013 tax data file in his name.

Loose translation: He never returned with any 2013 tax information and we already knew, at the time of filing, that any refunds from 2012 would not be made due to prior problems. He may have even owed the state?

I'm sure my suggestion in October was to come in as soon as possible with the 2013 stuff and accurate returns would be filed so that, hopefully, his past woes would end.

But. . . I never had any more contact with him until roughly a week ago. I have no idea what was done with his 2013 return. . .except that I was never involved.

I think the applicable term is something like "selective memory recall" ??

FE

[geekgirldany]

Teluwhut (Alabamese for "Tell You What"): Pay IRS everything they can throw at this guy. Then sue his company in small claims court for the money and see how detached they are.

Would be a good idea but it is a major bank not so sure how far they would get.

Good thing is the client has moved all their accounts to another company plus closed the business. So hopefully nothing like this will happen again with them in the future.