401k rollover issue
In late 2019, a client left his job and rolled his 401(K) to an IRA with us. The client dropped two checks off at our office (both made payable to Client’s name IRA) that had been sent to him from the 401(K). In 2024, it was discovered that one of the checks was from the client’s traditional 401(K), and the other was from his Roth 401(K), but both were deposited in the traditional IRA. The client wants to remove the Roth 401(K) portion from the IRA and put it into a Roth IRA, along with any calculated earnings. We are looking for advice as to how to best handle this situation and get the Roth money out of the IRA and into a Roth IRA while hopefully avoiding any tax consequence/penalty to the client. Thanks.
Permalink Submitted by Alan - IRA critic on Wed, 2024-05-22 17:07
While still a hassle, this type of error can usually be corrected if discovered within 60 days of the distribution because a 60 day rollover can still be completed using other funds or using the misdeposited funds after they have been removed from the TIRA as an excess contribution.
But 5 years, unless the amount is large enough to justify a PLR Request, there is no way to get the funds into a Roth IRA. The question then becomes whether the client wants to roll the dice regarding the excess TIRA contribution annual 6% excise taxes or take a distribution of the excess (no earnings) to stop the annual accrual of potential excise taxes indefinitely.
If the contribution is removed the 1099R will show it as fully taxable (double taxes) and subject to penalty if under 59.5. It might be possible to report the 1099R and not include the amount as taxable by providing full documentation of the error (2019 H coded 1099R and G coded 1099R along with the matching 5498 from the Roth custodian equal to the 1099R totals). But that essentially alerts the IRS to the excess contributions since 2019 with no SOL and therefore would require a 5329 to be filed with a 1040X for each year (2019-2023), pay the excise taxes and the IRS will likely bill late interest for these delayed tax payments.
Accordingly, the client might consider doing nothing at this point (rolling the IRS dice) or perhaps just distributing the excess and paying the tax and penalty to avoid adding additional potential excise tax years as there is no SOL without filing a 5329 for years prior to 2022.
I have seen several of these errors in the last year, but none of them went more than a few months out before discovery. Most of these taxpayers attempted correction, but got little cooperation from IRA custodians, and therefore gave up the effort. I hope the Roth amount was small.
Permalink Submitted by Jennifer Kevitt on Thu, 2024-05-23 16:49
Thank you for your helpful information. Regarding possible solution of providing full documentation of the error (2019 H coded 1099R and G coded 1099R along with the matching 5498 from the Roth custodian equal to the 1099R totals) – would it be possible the IRS would consider waiving the excise tax and late interest due to the fact this was an innocent error that the client did not benefit from, nor did purposefully to benefit in any way, and therefore should not be penalized for? Could the client try to sign a self-certification letter using the reason “An error was committed by the financial institution making the distribution or receiving the contribution?” Thank you!
Permalink Submitted by Alan - IRA critic on Thu, 2024-05-23 18:04
The IRS does not even have the authority to waive the excess contribution excise tax, however the documentation of applicable 1099R/5498 forms that show the source of the distribution (Roth 401k) might be helpful in getting the IRS to not treat the excess distribution as taxable. If client chooses to remove the excess contribution, it may be worth an attempt to convince the current TIRA custodian that the removal is being requested under Sec 408(d)(5) and should be reported with Box 2a left blank on the 1099R. Custodian may or may agree, but if they do it might avoid having to convince the IRS that the contribution had never been deducted.
As for Rev Proc 2020-46, the custodian would likely not accept the form due to the 5 year delay. Further, this does not sound like custodian error unless client made a copy of the direct rollover checks and the Roth 401k check payee indicated a Roth IRA of the client.
I have seen several of these errors made because the taxpayer indicated the wrong IRA account number to the receiving custodian, but direct rollover checks not separately made out to the “IRA” or “Roth IRA” add to the chances of error.