Received Corrected 1099-R with Code E

Submitted by Jon Tomko on Wed, 2021-03-17 17:37

Two weeks ago I filed my taxes for 2020. A few days ago (after I filed for 2020) I received a corrected 1099-R with a code E from my previous employer’s 401k administrator, for 2020. Today, I received a letter in the mail from my former employer explaining the issue.

The letter explains that because my former employer decided to halt 401k matching last year, starting June 1st, 2020, they inadvertently miscalculated maximum amount of income the plan was able to match. Normally, the plan has a matching maximum of $7,500 ($1 matching per $1 contributed), but because they halted matching on June 1st, they apparently needed to prorate the maximum amount of income they could match, which lowered that maximum match from $7,500 to $7,125. I had actually hit the maximum contribution before June 1st, so they had made $7,500 in matching contributions to my 401k before the halted the matching. However, that means they later found out they overpaid their matching by $375. The former employer is asking that I return the $375 plus whatever interest they calculated, which amounts to $463.02.

In the meantime, I had left that employer in the fall of 2020 and immediately rolled my 401k account into my Rollover IRA and Roth IRA. And since then, in 2021 I actually moved my IRA accounts to another administrator to consolidate accounts.

So, back when I did my taxes a few weeks ago, I had a 1099-R Code H and 1099-R Code G from the 401k administrator, for the rollover amounts. A few days ago, I received the corrected 1099-R Code G with the excess $463.02 (the $375 plus interest they calculated) removed and put into a corrected 1099-R Code E with the $463.02 marked as taxable.

Slightly frustrating that it took them this long to provide the corrected 1099-Rs, since I already filed my taxes for 2020, but I figure that if I file an amendment before the deadline this year I can avoid any major issues.

However, I’m not sure what to do with that excess $463.02 that is now sitting in my IRA. I did not make any IRA contributions in 2020, outside of the 401k to IRA rollovers, so I’m hoping I could just pay the taxes on the excess $463.02 and leave it in my IRA as a 2020 IRA contribution. I’m not against withdrawing all of it from my IRA entirely, but I figure that would just make things more complicated because it would be treated as a distribution.

Just looking for guidance on the easiest way to handle that $463.02 of excess, whether that be to just pay the taxes on it and leave it as an IRA contribution, since I didn’t make any others in 2020… or withdraw it entirely. Not sure if there are any more or less penalties with either approach.

Thanks!



Submitted by Alan - IRA critic on Wed, 2021-03-17 19:46

Yes, this has created a multi faceted mess.
Let’s address the principal first – are you going to return the funds?  Others in this situation have kept the money to offset the cost and hassle of the errors created by the plan administrators. The plan may or may not press you for the return. 
If you return the funds, then you are being taxed on 463 that you effectively did not receive. You can make a “claim of right” deduction if the amount exceeds 3000, but you can’t for this lower amount. And you can’t claim a misc deduction either since those were suspended. So this is another cost to you for their error. The cost and hassle of filing a 2020 1040X to report this income is also an obvious cost.
Now for the IRA contribution. You have a choice here. Since you have 2020 TIRA contribution space, you could treat the 463 as a regular TIRA contribution, but your income may be too high to deduct it. If you cannot deduct it, then you would have to file Form 8606 to report it as IRA basis. You may not want to carry a small amount of IRA basis in your TIRA and deal with Form 8606 from here out. If not, you could explain what happened to the TIRA custodian and that they should treat the 463 as a regular TIRA contribution for 2020 because that amount was not eligible to be part of the direct rollover they received. I assume they would have to make that distinction in their record keeping in order to return the 463 with allocated earnings in the TIRA. That would produce a 1099R next January with the earnings (amount in excess of 463) returned taxable and subject to penalty in the 2020 year because that was the year in which the contribution was made. The only deadline here is that if you want to have the IRA contribution returned, the deadline for that is 10/15/2021.  There is no rush for the amended return, and the IRS might not process it for several months anyway, so you have time to determine how you want to handle the TIRA contribution with respect to keeping it or removing it with earnings.

Submitted by Jon Tomko on Wed, 2021-03-17 21:16

Thanks for the quick reply and info, it’s helpful getting me in the right direction.I looked up the income requirements around deductions for IRA contributions, and you’re right, my income is too high to deduct it.So, it seems that my options are as follows:
Fill out Form 8606 to report the $463 as IRA basis. Is this something I will have to fill out every year, or just this year and then in the future whenever I take a distribution? I guess, what’s the downside to this option?
Explain to my TIRA custodian the situation so they can calculate/track the earnings, for which they will produce a 1099R next January and I will pay the taxes on that amount, with a penalty since it was due to a contribution in 2020. This option results in the TIRA custodian returning the $463 contribution plus earnings.
I think the problem with Option 2 is that I did not have an TIRA account with my current TIRA custodian in 2020. I rolled over from my 401k (Fidelity) to my TIRA (Fidelity) in September 2020, but then transferred my TIRA from Fidelity to Schwab in January 2021, to consolidate with other accounts. So, I would think Schwab wouldn’t be aware that this money was contributed in 2020. This just further complicates things, it seems.Are there any other options I’m missing?Also, regardless of which option above I move forward with, I’ll still be paying the taxes on the $463 this year when I submit my amended 1040X, correct?I really appreciate the help.

Submitted by Alan - IRA critic on Wed, 2021-03-17 22:42

If you have IRA basis, you need to fill out an 8606 every year you take a distribution or make another non deductible contribution. Tax programs handle it quite easily, but it is an extra form. 
If you ask to have the 463 returned to you, the custodian will calculate the earnings and process the return right away. But the earnings will be taxable in 2020 and subject to 10% penalty if under 59.5.  This would be added to the1040 X for 2020 that you will need to file anyway due to the 1099R you already received. You would not have to wait for the 1099R to know what the earnings amount is.
You could explain the situation regarding the excess distributed to an IRA specialist at Schwab. They might process the retuned contribution as if the 463 was added on the date they received the rollover, or might have another default solution. Or they might ask for your IRA balance immediately after FIdelity received the rollover and use those figure to determine the “adjusted opening balance”.  This does add complexity, but they dealt with these situations before. They may even prefer that you determine the earnings and just give them the number for the period up to the date they received the funds.
If you did nothing, most likely nothing would happen other than the eventual double taxes on the 463. The usual 5498 reporting a regular IRA contribution would not be issued by any IRA custodian. 
Regarding other options, do you know if your MAGI is low enough to make at least a partial Roth contribution?  If it is, and if Schwab would cooperate, you could ask to have the 463 recharacterized as a Roth contribution. The earnings calc would still be an issue as it would be needed to recharacterize. But that would eliminate the 8606 and a distribution to you of earnings. It would be legal, but I cannot recall having seen this approach used before with this fact pattern.

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