Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:
This is a timely question, since the deadline for correction of a 402(g) excess deferral for 2017 is fast approaching. And indeed, the Experts have not addressed this issue since 2013. Although the correction principles have remained the same since that time, it would be appropriate for us to provide a refresher to our readers.
First, the plan’s recordkeeper should be notified of the amount of the excess deferral. The recordkeeper 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 recordkeeper must distribute the excess deferral by April 15, 2018, you should notify the recordkeeper 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 2017 1040 tax return. Also note that the participant must file a 1040 tax return for 2017: 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 (2018 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 2018 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 2018, but there is a special reporting procedure. The loss amount is reported as a negative amount on Line 21 of the 2018 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 Internal Revenue Service (IRS), the recordkeeper will generally issue two 1099-R reporting forms in early 2019; one for the principal amount of the excess deferral (already declared by the participant as income in 2017) and one for the earnings attributable to the excess deferral (which the participant would report as income, as described above, on his/her 2018 1040 tax return). However, 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.
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.
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