We have a participant who exceeded the 402(g) limit for 1997 and 1998. The vendor has told us that the correct manner to correct the problem is to issue corrected W-2s. Everything our payroll department reads indicates that the vendor should refund the excess contribution (and interest) and issue a 1099-R. (Note: today is 2/2/99 so they'll be late) Has anyone ever dealt with a problem like this and are there sources on the net that can help us? The vendor's general counsel is pushing the W-2 solution, citing Treasury Regs that we can't locate.

IRS regs § 1.402(g)-1(e) discusses corrective distributions of excess deferrals. A plan may provide that an excess deferral can be distributed to the employee. This can happen either during the tax year or before April 15 of the following year, and slightly different provisions apply in these two cases.

If the plan does not provide for a corrective distribution or for other reasons there is no distribution by April 15, the money must stay in the account. It is still taxable during the year of contribution, though, and it is taxed again when distributed.

IRS Publication 575 is helpful on these matters: on page 18 of the 1998 edition it advises the employee that if he/she does not get a distribution from the excess deferral, he/she must report it on the tax return but the employer does not show it on the W-2.



[Note: This message has been edited by CVCalhoun]

If you mean the $10K limit, there is really no good reason that this should be exceeded. Seems like some improvements may be needed in the payroll system.
If you mean the 402(g) limit, subject to subsection (8), that might be a bit more difficult.

Actually, there are good reasons why this could happen. The most obvious would be if the participant were doing a "catch up".

Our payroll system can put a dollar limit on withholding but that would only cover us for the 402(g) limit. We can't do all the other MEA tests without endangering our ERISA exemption on this plan. Basically, we've taken the position that the vendor and the participant are responsible for doing the tests. Our roles is to withhold funds as directed by the participant and remit them to the insurance company.

We're straying from the original question. Any preferences as yet? W-2 or 1099-R?

BTW, we met with the vendor and they said they had three sources, two of whom are in agreement with our assessment (that they should use a 1099-R). I have the letter on my desk from the participant requesting a refund but it is addressed to me and not the insurance company. The clock is ticking. . .

I really appreciate the interest in this question, especially the IRS links.

As a matter of course, your interpretation would be the correct one; Disburse the funds and report the distribution on Form 1099-R. Since the funds are being physically removed from the account in 1999, the participant will receive a 1099-R for 1999 with a code "P" (indicates disbursement is taxable in a year prior to 1999). This must be completed and the funds disbursed prior to April 15, 1999 if you are going to report the excess distribution amount as taxable for 1998. If you do not distribute the excess, then the funds must remain in the account; they become taxable BOTH for 1998 and the date which they are actually disbursed from the account (pursuant to a standard triggering event).

To correct an excess deferral by issuing an amended W-2 would imply that the contribution never took place. Since a vendor has a custodial reponsibility to report actions as they occur, a custodian cannot summarily pretend to re-write history and report the events as they would like them to have happened. These are the types of actions IRS auditors look for.

[This message has been edited by RMassa (edited 02-08-99).]