Rollover Error/Tax Reporting

Submitted by Kevin O'Hearn on Tue, 2022-11-01 18:17

Hello,

A client had an IRA and a 401k. The IRA had both pretax and after-tax contributions in it and the client wanted to roll their IRA to their 401k. We know after-tax contributions cannot be rolled to a 401k, however in error the client requested a direct rollover of the full amount. My questions are:

1. The after-tax portion in the 401k must be removed, correct?

2. Can the after-tax portion be rolled back to the IRA as a direct rollover? Or must it be sent back to the participant and remain outside of a retirement plan/IRA?

3. Any idea what responsibility the delivering IRA custodian has here from a reporting standpoint? The TPA of the plan is requesting that a corrected 1099-R be issued by the IRA custodian showing only the pretax rollover amount be distributed, but the custodian will not do it. They also want them to suppress 5498 reporting of the money being rolled back to the IRA. The TPA referenced a section from the 1099-R and 5498 instructions that says custodians must issue corrected forms when they are made aware of errors such as ineligible rollover amounts such as RMDs amounts. In my opinion here the custodian did not make an error and there is no way for them to know if an IRA contain after-tax money or in the RMD example, whether a client may have satisfied their RMD from another account. Seems like the instructions for corrected forms may apply to qualified plans only.

Curious of your thoughts. Thanks!



Submitted by Alan - IRA critic on Tue, 2022-11-01 20:30

  1. Yes, it was not eligible for rollover. However, if client had another IRA with enough pre tax dollars in it, client would avoid the rollover of IRA basis.
  2. The latter. The 401k plan should not be doing direct rollovers of “excess amounts” in the plan as they are not eligible for rollover. They should be distributed with a 1099R coded E or some other code indicative of amounts that are not eligible for rollover. Nonetheless, some plans are inclined to attempt the direct rollover solution. If they do, they can expect the IRA custodian to issue a 5498, otherwise there would be a mismatch at the IRS relative to the taxpayer’s return.
  3. IRA custodians often do not cooperate as well, particularly after the G coded 1099R has been issued. They do not like to revise already issued 1099R forms notwithstanding the 1099R Inst to correct errors. The correct practice would be to reissue the G coded 1099R to include only the pre tax amounts eligible for rollover to a QRP, and another 1099R for the distribution of basis, coded 1 or 7. This 1099R would show the full amount as taxable and taxpayer would have to file an 8606 to apply IRA basis to it. If the IRA custodian will not cooperate the taxpayer would be left to issue a substitute 1099R and explain why to the IRS. At this point, I think many taxpayers are inclined to leave the IRA basis in the QRP and take their chances due to custodian inconsistency in determining the correct procedures, and tax filing hassles in reporting these multiple distributions.
  4. There may be a way to get the funds back in the IRA. The easiest situation is to complete a rollover using other funds within 60 days of the distribution before advising the plan of the excess. If the plan then distributes the excess it would reimburse the taxpayer for use of other funds to complete a 60 day rollover, assuming they are eligible for such a rollover. However, if the 60 days has already passed and the after tax amount is high enough, taxpayer might still be able to restore the IRA basis to the IRA through the self certification process per Rev Procedure 2020-46 using Reason 3. This also requires IRA custodian cooperation. 

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