401k complicated question

[Snaggletooth]

It may not be as complicated as I think, but it is definitely not mainstream stuff that we run into every day. A companion question can run into circumstantial instructions for the issuance of 1099-R.

A 2014 calculation of a client's 401k plan revealed a top-heavy amount due to the client. Normally, there is a refund sent to the participant and a 1099-R issued in the year AFTER the top-heavy amount is calculated. Sure enough, my client has a 1099-R issued in 2015 from the custodian.

In this case, there were options available to the recipient. In lieu of receiving the cash, the client refused it, and allowed the proceeds to be redistributed pro rata to the remaining participants. (There are some 30 other participants enrolled in the plan, other than himself).

To shrink this line of thought into a question, the question would be whether he owes tax on the proceeds he never received, or a companion question is whether the custodian is still obligated to issue a 1099-R even if the money was refused. Client has received a CP2000 from the IRS claiming taxes due on the distribution. If you "follow the money" it would appear that the custodian would have issued additional 1099-Rs to the other participants, or maybe NO 1099s if the redistribution does not result in a cash payment to those participants.

Comments and answers appreciated. Snag

[Roland Slugg]

A top-heavy plan must meet stricter vesting rules and a is subject to a higher minimum contribution requirement. I am not aware of an option allowing any kind of redistribution like you described.

It sounds to me like the employer simply contributed too much for the key employee in question, and the excess was required to be taken back out to avoid hefty penalties and even possible plan disqualification. If that's what happened, the 1099-R reporting the distribution is correct, and that should end the matter. If the employee elected to allocate his refund among other plan participants, I believe those contributions should simply be treated as current-year contributions on those employees' behalf. If he did that, perhaps the refund can be treated as if it was sent to the employer, not him, and the income reported on the 1099-R form not taxed to him, but to the corporation instead. Not sure about all that.

If this isn't the case, I suggest the matter be referred to the plan's outside administrator for guidance.

[New York Enrolled Agent]

It may not be as complicated as I think, but it is definitely not mainstream stuff that we run into every day. A companion question can run into circumstantial instructions for the issuance of 1099-R.

A 2014 calculation of a client's 401k plan revealed a top-heavy amount due to the client. Normally, there is a refund sent to the participant and a 1099-R issued in the year AFTER the top-heavy amount is calculated. Sure enough, my client has a 1099-R issued in 2015 from the custodian.

In this case, there were options available to the recipient. In lieu of receiving the cash, the client refused it, and allowed the proceeds to be redistributed pro rata to the remaining participants. (There are some 30 other participants enrolled in the plan, other than himself).

To shrink this line of thought into a question, the question would be whether he owes tax on the proceeds he never received, or a companion question is whether the custodian is still obligated to issue a 1099-R even if the money was refused. Client has received a CP2000 from the IRS claiming taxes due on the distribution. If you "follow the money" it would appear that the custodian would have issued additional 1099-Rs to the other participants, or maybe NO 1099s if the redistribution does not result in a cash payment to those participants.

Comments and answers appreciated. Snag

The Supreme Court in Culbertson said the "first principle of income taxation" is that gains should be taxed to those who earn them (the assignment of income doctrine).

Your client was entitled to the excess 401K money - IMO it's taxable to him and only him.

[Snaggletooth]

Good Discussion

Thanks to both of you for tackling this tough question. Client is not going to like it because when he returned the money he probably had no idea he would be taxed on it.

Apparently, from your responses, if the distribution was made available to him, it is taxable.