W-2 employer's 401k failed ADP/ACP testing and I'm getting a taxable corrective distribution. Can I put this in solo 401k?

Submitted by Matthew Kleiber on Fri, 2023-03-17 20:35

I had 1099 and W-2 income income in 2022. My W-2 employer’s 401k failed ADP/ACP testing and I’m getting a taxable corrective distribution of about $2,100. Does this now free up 2022 contribution space, and could I now make a 2022 contribution to my solo 401k?

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Permalink Submitted by William Tuttle on Sat, 2023-03-18 03:00

As Alan indicated in two separate posts in the last day. Distributions of excess contributions are never rollover eligible. Using separate funds for employee deferrals would be subject to other restrictions.
If the employee deferral limit has already been reached. A return of excess contributions does not restore the employee deferral space.
Even if you have unused employee deferral space including the excess contributions. You could only make an employee deferral to a one-participant 401k in the unlikely event you had an enabling employee deferral election in place by 12/31.
You would need an employee deferral election something to the effect; “100% of compensation up to the employee deferral limit less deferrals to other 401k, 403b and SIMPLE IRA plans and within the annual addition limit.”

Permalink Submitted by Matthew Kleiber on Sat, 2023-03-18 19:54

Ok, since it sounds like I cannot make an additional employee deferral, I am wondering what the reporting would look like here. I already rolled over the funds from my old employer 401k to my Solo 401k, so I’ll need to withdraw the $2,100 plus any investment gains. I think what I need to correct is the Solo 401k needs to issue me a 1099-R for 2022 showing gross distribtion in Box 1, any investment gains in Box 2a, and Box 7 should show the distribution code 8 for excess contribution. Does this sound right?

Permalink Submitted by Alan - IRA critic on Sat, 2023-03-18 20:40

When did you roll over the old 401k, and did the plan just send you a letter that 2100 of the rollout was an excess contribution? If so, they should issue a 2023 1099R coded 8 next January at the latest and another 1099R coded G for the remaining balance rolled over to the soloK. Then, as you indicated, you will have to distribute the excess amount in the solo K adjusted for gain or loss and the solo K will have to issue a 2023 1099R coded E to report the corrective distribution. In other words, the taxable distribution of the excess should be reported from the old K plan, and that amount then becomes an after tax excess amount rolled into the solo k that must be distributed adjusted for gain or loss. The 1099R from the solo K should show the gain (if any) in Box 2a and the difference between the gain and the gross distribution in Box 5. That will prevent double taxes on the same excess amount being distributed from two different plans.

Permalink Submitted by Matthew Kleiber on Sat, 2023-03-18 21:18

Let me describe the timing of events: March 2022- I contribute $20,500 to employer 401k for 2022. I leave W-2 employer and roll Transamerica 401k balance to my Vanguard IRA December 2022- I set up a Solo 401k and make an employer contribution based on my self employment income for the year January 2023- I make a transfer of assets from Vanguard IRA to Solo 401k February 2023- I receive email from W-2 employer informing me their 401k plan failed ADP testing, and I’ll be receiving a corrective distribution as an HCE March 2023- I recieve two 1099-Rs from Transamerica. One has gross disbution of of $18,198 with code G, second has gross distribution of $2,401.55, taxable amount of $2,401.55, and code 8.

Permalink Submitted by Alan - IRA critic on Sun, 2023-03-19 00:09

This is a nasty scenario because of the double transfer. Since you had already done a complete rollover from the 401k, the wording on the e mail is not accurate. What it should have said is that the distribution was already done in Dec 2022 and the 1099R forms reporting that rollover have been split into two parts – the G coded 1099R for the allowed rollover and the Code 8 1099R for the excess contribution portion that was not eligible for rollover and will be taxable in 2022, but no penalty applies. The problem here is that your IRA received an excess contribution that in turn was rolled into the solo K (second transfer), creating an excess amount in the solo K that must be removed from the solo K. It’s March, so I have seen around 6 similar situations posted where an excess amount was quickly rolled into another account before it could be corrected, transferring the problem to a 3rd account. This issue will now span 2 tax years. 2022 is the easy part – you can just report those 2 1099R forms as issued and you will have $2,402 more taxable income in 2022.
The IRA to solo K direct rollover will be reported on a 2023 1099R received next January for 2023. I doubt that VG will agree to split there 1099R into two parts like the 401k did, but you could attempt to convince them that $2,402 of their direct rollover was an excess contribution from the 401k, therefore that amount adjusted for gain or loss from Dec 2022 to the Feb distribution date should be reported as a return of a 2022 excess contribution and the remainder on a G coded 1099R. They may not do this or could mess it up. If they refuse to report anything other than a full direct rollover after your explanation, then you have a choice. Either roll the dice and report the 1099R they will issue or issue your own corrected 1099R forms using Form 4852 (substitute 1099) to report the IRA to solo K rollover. Either way, the excess is now in your solo K due to the double rollovers and it must be removed adjusted for gain or loss (likely a loss) since Feb. If you administer your solo K and have to issue your own 1099R forms to report the distribution of the excess from the solo K, I would use Code E in Box 7 and if there is a loss since Feb, show the gross distribution in Boxes 1 and 5, nothing in 2a because you already paid taxes on the excess with your 2022 return. If a custodian will handle tax reporting for the solo K, you will have to explain this mess to them and hope they issue the 1099R this way because if they show the entire distribution as taxable then you are double taxed on the ~$2402. So the bulk of this hassle will be with your 2023 return, not 2022.

Permalink Submitted by Matthew Kleiber on Sun, 2023-03-19 15:31

Appreciate your help with this, Alan! I administer the Solo 401k so I will handle that reporting. Thanks again so much for explaining.

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W-2 employer’s 401k failed ADP/ACP testing and I’m getting a taxable corrective distribution. Can I put this in solo 401k?

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