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Archive for November 2009

I got a return of contributions to my 401(k). What do I do?

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I’ve had to file more than one amended return in this situation, with penalties and interest accruing to the taxpayer, and I thought this would be a good place to start.

You manage a local retail branch of a small regional chain. Your employer offers a 401(k) plan, in which you choose to participate, donating the maximum allowed. You get your W-2 in January, and it shows the amount you deferred in Box 12 with code D. In February, you get a check in the mail from your 401(k) plan administrator. The check comes with a note that says your company’s 401(k) plan failed a test, and to bring the plan into compliance some of your “excess contributions” are being returned to you, along with any interest those contributions earned during the period they were invested in your plan. You are puzzled but do nothing, and file your taxes normally. One year later, you receive a Form 1099-R from the plan administrator showing a distribution in the amount of the check, with Code 8 in Box 7. You file it with your return accordingly, and are stunned to get a letter from the IRS in July claiming that you owe back taxes on that income from two years ago.

401(k) plans cannot be biased in favor of highly-compensated employees (HCEs, defined as anyone who owns at least 5% of the company, and anyone who makes more than a defined dollar amount). If HCEs contribute too much more to the 401(k) plan than do non-HCEs, as a percentage of income, the plan is non-compliant and must be brought into compliance. Frequently, this is done by refunding enough of the contributions made by the HCEs to bring the percentages contributed by HCEs down to the required level. (The employer can also make a contribution on behalf of the non-HCEs to bring their percentage up, but this doesn’t happen as often, in my experience). The refund must include not only the excess contribution but also any income earned by those contributions during the period of time they were invested in the plan.

Those distributions – both the return of contributions and the income earned – are taxable in the year the contributions to the 401(k) were made, even though the return distribution isn’t made until the following year. They are treated as though they were never made – they should have been part of your taxable wages for that year on your W-2 – and you have to treat them the same way on your return.

If you get a check for return of excess 401(k) contributions in 2010, you must include the amount that you received as wages on your 2009 return.


Written by nctaxpro

November 19, 2009 at 2:20 pm

Posted in Retirement, Taxes