Miller

[tpnl]

Client received a letter stating he will get a refund of excessive contributions to his 401(K) because he is a highly compensated employee. The letter states the refund amount but does not indicate what might be the earnings. Refunded contribution go on 2006 or 2007? Earnings will go on 2007? Should I wait to see what the 2007 tax year form states before I take action?

[Luis Mopeo]

Client received a letter stating he will get a refund of excessive contributions to his 401(K) because he is a highly compensated employee. The letter states the refund amount but does not indicate what might be the earnings. Refunded contribution go on 2006 or 2007? Earnings will go on 2007? Should I wait to see what the 2007 tax year form states before I take action?

You'll probably see a 1099R code P, excess deferrals and earnings taxable in 2006. Then you have to do an amended return.

[ChEAr$]

401k refunds

should be taxable in the year received. However I've only seen them
reported on a W2 form, since they were pre tax in the first place.

[New York Enrolled Agent]

Luis

Correct me if I'm wrong but doesn't §4979 treat the year of inclusion as a function of when the distribution is made. If during the first 2½ months of 2007, then it is reportable on the 2006 return. But after 2½ months, I read it to be included as income in 2007.

BTW, in the older post on this Bees & I agreed there would be no 10% penalty. I found a better cite that clearly says no 10% penalty (see the last sentence). Reg. §1.401(k)-2(b)(2)(vi)

A) General rule. Except as provided in this paragraph (b)(2)(vi), a corrective distribution of excess contributions (and income) that is made within 21/2 months after the end of the plan year for which the excess contributions were made is includible in the employee's gross income on the dates the elective contributions would have been received by the employee had the employee originally elected to receive the amounts in cash, treating the excess contributions that are being distributed as the first elective contributions for the plan year. A corrective distribution of excess contributions (and income) that is made more than 21/2 months after the end of the plan year for which the contributions were made is includible in the employee's gross income in the employee's taxable year in which distributed. Regardless of when the corrective distribution is made, it is not subject to the early distribution tax of section 72(t).

[Luis Mopeo]

I was going by Pub 560, "Treatment of Excess Deferrals."

"Excess not withdrawn by April 15. If the employee does not take out the excess deferal by April 15, 2007, the excess, though taxable in 2006, is not included in the employee's cost basis in figuring the taxable amount of any eventual benefits or distributions under the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed..."

I know we rely on Pubs at our own risk, but this appears to say taxed in 2006, and taxed again in 2007.

[New York Enrolled Agent]

Luis

I gather from the original post that this is an excess contribution and not an excess deferral. They are treated differently for tax purposes.

The post from TPNL says the contribution is being returned due to the "highly compensated" employee rules. Thus I think the corrective distribution rules pertaining to excess contributions are in effect here.