(b)lines Ask the Experts – Correcting 457 Plan Excess Deferral not Returned

October 27, 2009 (PLANSPONSOR (b)lines) - A plan provider asks, "What correction procedures can be implemented for an excess deferral from a prior year in a governmental 457(b) plan that was never distributed to the participant? In addition, what are the taxation and reporting rules regarding a distribution of the excess deferral at this time?"

Answer from David Powell, Groom Law Group, Chartered


Whether distributed or not, the amount of the excess deferral is taxable to the participant under the 457(f) rules in the later of the year the excess deferral is made or it is no longer subject to a substantial risk of forfeiture (see Treas. Reg. §1.457-4(e)(1)).   Note that, because governmental 457(b) plan assets must be held in trust, this will mean that the earnings on such excess deferrals in such a trust are also taxable each year as they arise rather than the year paid, unless also subject to a substantial risk of forfeiture.   See Treas. Reg. §1.457-11(a)(3).

The IRS has not issued guidance on how these amounts are reported.   Because these are not treated as amounts deferred under Code section 457(b), one view is that they should be reported on Form W-2 (or W-2C) for the year taxable, rather than on Form 1099-R.   However, IRS Notice 2003-20 and the Instructions to the Form 1099-R provide that “all amounts that are paid from the governmental § 457(b) plan” are reported on Form 1099-R, so there is some support for doing so.   Also, note that excess 457(b) deferrals may have FICA tax consequences.

As a correction procedure, the plan should monitor the contribution limits (the dollar and 100% of compensation limit, the age 50 catch-up for governmental plans, and the last-three-years catch-up) annually and make corrections in the year the excess is made or as soon as practicable thereafter.   Keep in mind that all 457(b) plans that the individual participates in of the same employer are treated as a single plan for this purpose.

NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.