“The participant does not qualify for the age-50 catch-up election, and our plan does not permit use of the 15-year catch-up election. How do we address the excess? The participant’s W-2 has yet to be produced, so we could adjust the W-2 if necessary?”
Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:
A timely question, since no doubt many plan sponsors are in the process of reviewing year-end records to confirm there were no excess deferrals to their retirement plan(s). With the increased automation of retirement plan operating systems, the number of excess deferrals appears to have dropped. In fact, an inquiry regarding excess deferrals has not been posed to the Experts in nearly two years (see “Ask the Experts: Correcting Excess Deferrals”).However the information provided in that 2011 Ask the Experts column remains timely. First, the plan vendor should be notified of the amount of the excess deferral. The vendor will then calculate the earnings attributable to the excess and issue a distribution to the participant in the amount of the excess, plus earnings (or less losses, if any). Since the vendor must distribute the excess deferral by April 15, 2013, you should notify the vendor immediately of the excess deferral. It is important that NO adjustments be made to the participant’s W-2 (i.e., the entire amount of the deferral, including the excess, should be reflected in Box 12 of the W-2).
You should also inform the participant immediately of the excess deferral amount as he/she will need to add the amount of the excess deferral to Line 7 (Wages, salaries, tips, etc.) of his/her 2012 1040 tax return. Also note that the participant must file a 1040 tax return for 2012: he/she cannot file a 1040A or 1040EZ. Similar rules apply to the participant’s state income tax filing, with the exception of states that do not recognize an income tax exclusion for deferrals in the first place (e.g., New Jersey, where ALL 403(b) deferrals-but not 401(k) deferrals-are taxable as income).
As for the income attributable to the excess deferral, such income will be taxable in the year of distribution (2013 in this case). Although the IRS procedures are not specific in this regard, it is presumed that such income would be added to Line 7 of the 2013 1040 return (again, the participant must file a 1040). If a loss (rather than income) is attributed to the excess deferral, it is also reported on the participant’s 1040 for 2013, but there is a special reporting procedure. The loss amount is reported as a negative amount on Line 21 of the 2013 1040 (Other Income) and the type of income must be identified as a “Loss on Excess Deferral Distribution.”
As for the official reporting of the transaction to the IRS, The vendor will issue two 1099-R reporting forms in early 2014; one for the principal amount of the excess deferral (already declared by the participant as income in 2012) and one for the earnings attributable to the excess deferral (which the participant would report as income, as described above, on his/her 2013 1040 tax return). If a loss is incurred with regard to the excess deferral, only one 1099-R will be issued. 1099-Rs are for IRS reporting purposes only, and are not attached to tax returns.
The Experts thank you for your timely question!
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.