401K and rollover IRA both reporting same excess contribution in different years

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  • #22779
    deedee8712
    Participant

    1) I contributed to company 401K plan in 1Q2020
    2) I took at complete non-taxable distribution to a rollover IRA in Apr2020
    3) In Jan2021, received W-2 that listed 401K deduction and received a 1099-R for the non-taxable rollover
    4) 3/15/21 got email from previous employer that said 401K failed ADP/ACP test in 2020 plan year and I was required to take a distribution of $2500 excess contribution
    4) 4/12/21 401K provider sent recharacterized and corrected multiple 2020 Forms 1099-R one with $2500 taxable distribution and a second with the balance non-taxable. Letter with details arrived five days later.
    5) 4/14/21 I took excess contribution removal of $3400 from rollover IRA which included $2500 for the original excess contribution and an additional $900 earnings (calculated by the rollover IRA provider) since the rollover.

    The problem is: How to I complete my e-file-able taxes?
    1) Form 1099-R instructions provide details how 401K company should recharacterize the distributions in the plan year (2020) if there was a full distribution and subsequently the 401K failed ADP/ACP test in the first 2 1/2 months of the next year (2021).
    2) However, Form 1099-R instructions provide details how the rollover IRA provider treats a removal of excess contributions in 2021. They issue a 1099-R including both the excess contribution removal (taxable in 2021) and earnings of the removed amount (taxable in the year they were earned). Form 1099-R would be issued in Jan 2022.
    3) In 2020, I should report the excess contribution from the 401K (+ neglible earnings) + 2020 earnings from the rollover IRA excess contribution
    4) In 2021, I should report the 2021 earnings from the excess contribution to the rollover IRA

    Problems:
    1) Two companies are reporting the same excess contribution removal as taxable in two different years.
    2) How do I report the 2020 earnings from the rollover IRA before the Form 1099-R is issued?
    3) How to I e-file and also explain the conflict so the IRS does not flag my return?

    #22888
    Alan S.
    Participant

    1) The 401k excess is only taxable once. The corrective distribution from the IRA 1099R should only show the earnings (900) taxable, however because the excess TIRA contribution was made in 2020, those earnings will be taxable in 2020 as well. The 1099R from the IRA will be coded to indicate the earnings are taxable in 2020.

    2) Some tax programs will require you to make up a dummy 1099R as if you had it now. You know what the earnings are (the amount distributed less 2500). You would show 3400 in box 1, 900 in 2a, Code P in box 7 (also code 1 if under 59.5). But if the dummy 1099R must be a 2020 1099R then use code 8 in box 7 since the dummy 1099R will be one year early. End result is that the 900 should be added to 2020 taxable income line 4b.

    3) Remember, your two 1099R forms from the 401k replace the first one and should indicate “corrected”, so do not enter the first 1099R from the plan that was replaced to separate out the excess portion.

    4)If you are using a program like Turbotax, they might offer guidance on how to enter the info. This situation is fairly common.

    #26461
    deedee8712
    Participant

    Alan, thank you very much for your prompt and detailed response. Sorry it took me so long to reply. Because I know of your consistently being right in this forum, I took your comments very seriously even though it contradicted the Form 1099-R instructions and verbal comments from (rollover IRA provider) Vanguard Retirement team personnel and another company-provided 401K advisor. It also was not what I remembered when I had a similar excess 401K contribution (without earnings) twelve years ago in 2009.

    I dug into my paper boxes and found my 2009 tax forms and as you suggested the amount of excess contribution on 2010 Form 1099-R had code 1P in Box 7. So you were right and everyone else was wrong about what the rollover IRA provider would report in 2022 (code P in Box 7). Then I wrote an email to the Vanguard retirement team and asked about the specific amounts and codes and check marks in each box that I should expect for my 2022 Form 1099-R. This time I got the correct answer. Alas I needed to know the right answer to know what question to ask.

    I started to enter a dummy 1099R into H&R Block desktop software but it would not add a comment and I did not like that approach. Instead under the other income category I chose “2020 IRA contribution returned to you in 2021” which prompted me to “enter amounts for the returned IRA contribution in 2021” and then prompted me for “the IRS requires a statement explaining the withdrawal” for a four line statement. I explained the full distribution to a rollover IRA and the failed 401K ADP/ACP plan and the excess contribution and the earnings. The earnings value appears on line 4b as you suggested and the explanation appears on the last page of my return.

    I do not understand why the earnings on the excess contribution, eight months of which were in 2020 and four months of which were in 2021, are all taxed in 2020, but I’m not in a position to question it.

    #27329
    Alan S.
    Participant

    Earnings on excess IRA contributions are always taxable in the year in which the excess was contributed. But when a 401k fails a test and distributes earnings, both the excess and earnings are taxable in the year distributed, not contributed. However, in your case you did a direct rollover, which is treated as including the excess contributions, so they were distributed from the 401k in 2020. In this case, 2020 became the taxable year for both due to transaction timing.

    Don’t think I mentioned it before, but the 2500 excess contribution return from the 401k should show on on the wages line of Form 1040, not on line 5 for retirement plan distributions.

    • This reply was modified 4 months, 3 weeks ago by Alan S..
    #27502
    deedee8712
    Participant

    Thanks again for your additional response. I understand your last paragraph; however, it is inconsistent with the corrected 2020 Form 1099-R from the original 401K provider and also inconsistent with the only 2020 W-2. Since the income totals are the same, I’m going to stick with using the data from the documents I have. If I do get audited, I can explain why I reported what I did and just change the line numbers for income without changing the total income reported.

    While researching this topic, I realized that I reported income in the wrong tax year for a similar excess contribution 12 years earlier. At the time, I did not realize the meaning of code 1P in Box 7 of Form 1099-R. I’m surprised neither the tax software nor the IRS noticed it. I probably paid the same tax rate in both years so it was a wash for the IRS.

    • This reply was modified 4 months, 3 weeks ago by deedee8712.
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