Treatment of 1099-R for prior year corrective distribution due to plan testing, when participant has rolled to IRA
I left a company in December 2020 and rolled my Fidelity 401k amount ($55,000) to a Vanguard IRA. In January 2021 Fidelity issued a 2020 1099-R Code G in Box 7 for the distributed amount of $55,000. I believe this is correct.
In March 2021 Fidelity informed me that due to plan testing failure, $7,000 is now being determined to be an excess contribution. They have issued two new 2020 1099-R’s one Code G of $48,000 (corrected) and one Code 8 for $7,000.
My questions/concerns are as follow:
1. Is this correct, since I believe corrective distributions for plan testing are taxable in the year received. Since the rollover was accomplished by the $55,000 going in a check directly from Fidelity to Vanguard I never had the money in 2020 and issuing a corrected 1099-R code 8 for 2020 ignores that. Participants that are still with the company received their corrective distributions by check which will be taxable to them in 2021.
2. Now that I have to instruct Vanguard to distribute the $7,000 from my IRA since it is excess, they say they will also issue a 1099-R Code 8. Thus I will have been issued two 1099-R Code 8’s for the same $7,000.
3. If Fidelity is doing this correctly, then how do I keep from paying Federal and State Taxes twice on the same $7,000?
I really appreciate your assistance as both Fidelity and Vanguard have no answers other than that is the way it is.
Mark
Permalink Submitted by Alan - IRA critic on Fri, 2021-03-12 19:40
It’s correct. Because you rolled over your plan balance in 2020 which turned out to include an excess contribution, your excess was distributed in 2020 and your 2020 return will include the 7000 as taxable. There was no plan balance left in 2021 from which to distribute the excess due to your rollover.
Since the 7000 was not rollover eligible, an excess IRA contribution was created, unless you were eligible to make a 2020 IRA contribution that you hadn’t made. If that were true you would not have an IRA excess. In other words, the 7000 is treated as if it was distributed to you and then you made a regular IRA contribution, even though the actual transactions were not done in that manner. Assuming that you cannot use that contribution as your 2020 IRA contribution space, VG should treat this as any other excess TIRA contribution and distribute it with any allocated gains. Since the contribution was made in 2020, any gains on the distribution will also be taxable in 2020. The 7000 itself is not taxable and there is no double taxation. The 1099R from VG should only show allocated earnings in Box 2a as the taxable amount. This 1099R will be issued next January, but coded P (not 8) which indicates that the earnings are taxable in 2020, not 2021.
Fidelity did their part correctly, and I presume VG will also, but their 2021 1099R will be coded P, not 8 since a returned contribution earnings are taxed in the year the excess contribution was made (2020). Therefore, you need to first decide if you can or want to treat the IRA contribution as an allowed regular IRA contribution for 2020 (may not be deductible), then if you decide to withdraw it you should do it now as that might provide your earnings figure in time to include it with your 2020 taxes. If you have already filed for 2020, you will have to amend your return or wait for the IRS to bill you for unreported income at some point. To be clear, if you can make the contribution (or 6000 of it if under 50), then you do not have to remove it and would never get the VG 1099R.
Permalink Submitted by Mark Beisswanger on Fri, 2021-03-12 20:41
Really appreciate the fast/complete response!