As we enter January of every year, it is time to start thinking about personal income taxes. While this is not a favorite to many, there are many important tax reporting forms that individuals must be on the lookout for over the next coming months. One of these is Form 1099-R – Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. One common use of Form 1099-R is to report corrective distributions of excess deferrals, excess contributions and excess aggregate contributions under various types of employee benefit plans.
Excess deferrals occur when participants’ elective deferrals exceed the Internal Revenue Code section 402(g) limit for the year. These limits are the maximum amount that each individual can contribute to all 401(k) plans. For example this limit was $16,500 in 2010 and is higher for participants age 50 or more. The employer is responsible for determining if this limit has been exceeded for employees that are participating in multiple employer plans. However the limit can also be exceed if an individual has multiple employers and is participating in unrelated plans. If distributed by the tax filing deadline for the year in which the deferrals were made (April 15 of the year following the year of deferral for most individuals), the excess is taxable to the participant in the year of deferral. If distributed after April 15, the excess is still taxable in the year the deferral was made and it is also taxed in the year of distribution. Therefore, in order to avoid double taxation it is imperative that plans refund excess deferrals to participants by April 15. Refunded earnings or losses attributable to the excess deferrals are taxable in the year distributed. As a result of the difference in taxable years for the return of excess deferrals and the refund of earnings or losses, a participant may expect the receipt of two separate Form 1099-Rs if the distribution was made after the year of deferral. To the extent the excess deferrals include Roth deferrals that were contributed on an after-tax basis; these amounts will not be taxable to the participant. However, any applicable earnings on the Roth deferrals will be taxable in the year of the distribution.
Excess contributions and excess aggregate contributions
A distribution of excess contributions or excess aggregate contributions may be made as a result of failure of the plan’s annual ADP or ACP testing. These limits are plan, not individual limits. Also, the determination of whether these limits have been exceeded is performed after year-end based on total participant compensation and contributions during the year. Therefore, in order to simplify the participants’ tax filings, the IRS allows for these refunds to be included as income in the year the refund is made. These corrective distributions must include allocable earnings or losses through the end of the plan year. The corrective distributions plus allocable earnings are taxable to the participant in the year the distribution is made. To the extent the excess contributions or excess aggregate contributions include designated Roth contributions; these amounts will not be taxable to the participant. However, any applicable earnings on the Roth deferrals will be taxable in the year of the distribution.
The gross corrective distribution amounts and taxable amounts are both reported on Form 1099-R to assist in reporting on a participant’s personal income tax return. Participants should contact their tax advisor to ensure that corrective distributions, including earnings or losses thereon, are properly reported on their personal income tax return.
Jonathan Poppel, CPA