403B final distribution –

Submitted by Lin Brand on Mon, 2018-04-02 05:46

My son’s Uncle died in 2016. In 2017 his Aunt, as trust executor, finalized the distribution of his 403B. She kindly decided to give some money to my son, BUT….he had no idea what it was going to do to his taxes. Apparently, it is all considered ordinary income as far as we can tell (she sent a K-1 form but she crossed out the first line which said “interest income” and just wrote in “403B”). Adding that money to his income means he ends up owing $18,000!!!!!
He’s 30 years old, he’s not rich and in fact has had a hard time finding work. This is crushing him, taking more than half of what he received. He used some to pay off his student loans and was hoping to have the rest as a cushion against his unsettled employment situation. Yes – he’s lucky to have gotten any money at all, he knows that, but it just seems crazy that so much will go away in taxes.

Sorry for the long story – the questions are: is it really ordinary income and not an inheritance or a gift? if it is, is there any way to spread it out so he doesn’t get hit by the taxes all on one year?

Appreciate any advise as he has to file pretty soon. Thanks in advance.



Submitted by Alan - IRA critic on Mon, 2018-04-02 15:00

  • His Aunt was obligated to adhere to the trust provisions if the trust was named as the 403b beneficiary. Was he a trust beneficiary or did the trust allow for gifts to be made?  What is obvious is that the K 1 was not completed correctly and there is no way to determine if the 1041 was other than to review both the trust and the 1041. That said, if your son had inherited the 403b direct, it would all have been ordinary income but he could have done a direct rollover to an inherited IRA and then stretched the distributions out. You didn’t indicate what his marginal tax rate is or if the 18,000 included amounts he would have owed without considering the trust distribution.
  • Don’t know if this could be considered a gift, but even if it was, then the trust would have had to pay ordinary income tax on the 403b distribution at a higher rate than your son. That likely would have reduced the amount available for any gift.
  • As reported, or even if the distribution was reported on the correct K 1 line, he would owe tax. But there is nothing that can be done without a review of the trust provisions, whether they were adhered to and whether the 1041 was completed correctly. The K1 should reflect the trust distributions. Was the 1041 prepared by a professional preparer?

Submitted by Lin Brand on Mon, 2018-04-02 15:30

Thanks for the quick answer. Nope, his Aunt did it herself. And I’m sure she wasn’t entirely sure what she was doing. My son was not a beneficiary of the trust. It all went to the Aunt. Then she decided to give some to my son on behalf of his Uncle. For 2017, he had fairly low income but also some Unemployment Insurance which didn’t have taxes taken out.  His total income before the trust was $37k. But the $50k “gift” from his Aunt jacked his income up to $87k (single filer) and also meant he had to pay back the Covered California subsidies he received for health insurance when he wasn’t working and even a small penalty for not paying enough tax during the year. Double-whammy, huh?  So he is out of luck and going to have to declare as ordinary income unless we get someone to go back and go through the entire trust?  Is there any likelihood getting his taxes done professionally will have a different outcome and be worth the cost?  He used Turbo tax premier; his taxes are usually so simple. Thank you so much for your help.

Submitted by Alan - IRA critic on Mon, 2018-04-02 17:28

His own taxes are probably correct, but the Aunt probably intended to pass the taxes from the 403b distribution through to your son. Otherwise, the taxes would come out of her share and she probably knew that and determined the amount of the “gift” accordingly. There is no easy solution to this, and it could get real messy, particularly if listing the 403b as interest on the K 1 is indicative how the 1041 was prepared.

Submitted by Lin Brand on Mon, 2018-04-02 17:42

Can you tell me where on the k-1 she should have listed it?  Yes, I suspect she intended to pass the taxes along.  So he’s stuck claiming it as income, I gather from what you have said. Yikes.

Submitted by David Mertz on Mon, 2018-04-02 21:14

I can’t see how it’s proper for your son to have been issued a Schedule K-1 if your son was not a beneficiary of the trust.  This sounds like a distribution from the trust to the Aunt which should be reported to the Aunt on a Schedule K-1 for taxation on the Aunt’s tax return, and an unrelated nontaxable gift from your Aunt to your son.  I think the trust tax return needs amendment and a corrected Schedule K-1 issued to your son showing that he received nothing from the trust.

Submitted by Lin Brand on Tue, 2018-04-03 05:13

We had a thought. Is there any reason the Aunt cannot file an amended K-1 and change the beneficiary to me?  I can keep the $ in a saving account for him should he ever need it, and my tax rate for the year is quite low since I am a senior and retired.  Would save about $10k if I received the funds.  Is that possible once his Aunt has already sent in all her tax stuff – can she change the beneficiary and send in new stuff?

Submitted by David Mertz on Tue, 2018-04-03 12:45

His Aunt must follow the terms of the trust.  If neither you nor your son were beneficiaries of the trust, it wouldn’t be proper for the trust to make a payment to either of you.  If this trust’s filed tax return is incorrect, his Aunt must amend it.

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