Corrective Distribution after a Rollover

Submitted by Nick Pappas on Mon, 2016-12-12 12:47

Client over contributed to 401k in 2015. Left employment in Jan 2016 and rolled 401k to IRA. The client can still avoid the 6% excise tax if he takes the corrective distribution from the IRA before 2016 taxes are filed, correct? And if so the IRA custodian should issue a 1099-R but how should it be coded? He rolled it to a credit union so they will not be familiar with this type of transaction and I am trying to assist them with how to proceed.
The previous 401k provider states that they will be sending 2 1099’s. One reflecting the excess contribution and one for the permitted rollover balance.

As long as the IRA distributes the excess contribution and the 1099 is coded correctly the full group of 1099’s will reconcile each other on 1040 and the client should be, correct?

Thanks in advance for your help in this matter.

-Nick



Submitted by Alan - IRA critic on Mon, 2016-12-12 16:50

  • If you are referring to the elective deferral limit for 2015, the client should have reported the excess amount on line 7 wages on his 2015 return. He also should be receiving 3 2016 1099R forms next month (not 2). One of those will report the distribution of excess deferrals coded P to apply to 2015 (probably already reported on 2015 return), another 1099R will show the taxable earnings on the excess deferral (taxable in 2016) and a 3rd 1099R should be coded G to reflect a direct rollover of the balance of the distribution total, the amount actually eligible for the rollover. If this excess is NOT from elective deferrals but an actual excess contribution, the 1099R forms will vary.
  • The excess IRA contribution will equal the amount of the first 2 1099R forms noted above.  This amount is treated as an excess regular IRA contribution made in 2016, so the deadline to make the corrective distribution from the IRA will be 10/15/2017 if client either files his 2016 return by 4/18/2017 or files a timely extension. After the corrective distribution including allocated earnings, the IRA custodian will issue a 1099R and the earnings will be taxable and may be subject to penalty for 2016. If you get the corrective distribution done THIS YEAR, client will have the 1099R next month which will indicate the taxable earnings to be added to line 15 of his 2016 return. The distribution code will be 8, but if the corrective distribution is not completed until next year, the 1099R will be one year later, but coded P to indicate the earnings are taxable in 2016. A little clearer for all parties if this can be completed this year. If client has a letter outlining the excess amount clearly, you can order the IRA corrective distribution now, but it might be safer to wait for the 1099R forms if there is any doubt about the numbers.
  • You are correct about communicating to the CU. Explaining why part of the direct rollover is an excess contribution is always difficult. Major brokerages probably understand the situation, but this may be difficult for a CU. They may ask for cites and otherwise not be able to get this done this month, but that is not a necessity, just more desirable. Their 1099R should NOT show the excess amount as taxable (taxes will be due from the 401k plan 1099R forms) just the earnings.
  • The 1099R forms must eventually reconcile with income reported in the correct year. But the IRA 1099R will only be issued in January if the corrective distribution is done this year. Otherwise, it will be a year later but still coded to apply to 2016.

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