We did a number of involuntary cash-outs (accounts < $5,000) in 2001. As it turned out two of our participants had bad addresses. It was not discovered that they never received their checks until 2002. The checks were never cashed; we stopped payment and reissued them in 2002. We are thinking there's no constructive receipt here (they didn't expect these checks).

Of course the 1099Rs reflect withholding and distribution in 2001 so the IRS is now saying they made ineligible rollovers. One of the participants put in his own money to make up for the withholding.

Our payroll says they will reissue a 1009R for 2001 showing only the withholding and a 1099R in 2002 showing only the distribution. This puts the participant who put in his own money in the position of making an ineligible roll of the amount equal to the withholding.

I wonder if this would qualify under Rev. Proc. 2003-16 for waiver of the 60-day rollover requirement .

Or, does the IRS prefer that the amended 1099R be handled differently ? We are not sure about showing the withholding in 2002 since it actually went to the IRS in 2001.

Surely this has to happen in other companies. What's the best way to handle this?

I decided to submit this question to the IRS and have received some guidance because this situation comes up periodically. Since so many people have helped me on this message board, I wanted to share what I have learned. The IRS advised that income not actually received is constructively received and reportable if it's within the taxpayer's control. The taxpayer neglected to change his/her address which was within his/her control.
So we will not make any corrections to the Forms 1099R that we filed in 2001. The participants/taxpayers will have to file amended tax returns showing the income (constructively received) in 2001.
I am waiting for a reponse to my follow-up question about whether that means they made ineligible rollovers or if they qualify for waiver of the 60-day rollover requirement under Rev. Proc. 2003-16.

I have a similar question except in this case the distribution is over $5,000. Plan terminated and all participants were give the option to do a rollover. After two notifications, if no response or return mail was received, a check was cut to the participant.

Now, two years later, participant is asking if they can rollover as check was sent to a bad address and never received.

Does the same "constructive receipt" apply even though distribution was over $5,000?

I disagree with the advice you were given by the IRS. I just saw the results of an audit that indicates taxpayers receive incorrect advice from the IRS 40% of the time. Anyhow, you might want to look at PLR 8833043, where a taxpayer who did not receive a distribution that was made in October of 1986 until July of 1987 because it was originally sent to an incorrect address was given sixty days from the date of actual receipt in 1987 to effect a rollover distribution, thereby avoiding including the distribution as income for either 1986 (the year in which distributed) or 1987 (the year in which received). Until a valid rollover is effected, the distribution should be treated as a taxable event. Any argument the participant may want to make to the contrary (e.g., a claim that the check was never received) is between the participant and the Internal Revenue Service.

I would not rely on a 15 year old plr. The case law provides that income is taxable in the year it is paid by the employer or plan, not the year it is received by an employee. Checks are frequently mailed on Dec 31, to meet year end requirements, e.g., MRD. A taxpayer cannot change the timing of the taxation of income because it is not received any more than sending the check back to the payor will will negate the inclusion of the amount paid in income. If the plan sent the check 2 years ago then the distribution would have been reported as taxable income on a 1099-R for 2001. There may be one exception to this rule. If plan cancels the prior check which was never received and sends a new check the taxpayer could take an audit position that the funds were paid in 2003. The plan would have to revise the 1099-R to show distribution in 2003 and the participant would need to file an amended return for 2001.

Obviously, no one should rely absolutely on anything that is posted here. However, I didn't intend to say that the income wasn't reportable as taxable to the individual, I simply meant to point out that until it is received by the individual, the time period for rolling it over (and thus deferring the tax consequences of the distribution) doesn't begin. (Come to think of it, maybe that is all the IRS was saying??) The statute provides that the time period for rolling a distribution over begins within 60 days of the date an amount is received, not the date the amount is sent. So, from a reporting perspective, I think it is correct to issue a 1099-R showing there was a taxable distribution, but from the perspective of the participant, I think he/she could successfully argue no inclusion in income if they can prove it wasn't received. That is my story, and I'm sticking to it.

The IRS did not address the issue of the rollover. They addressed the issue of when the distribution was taxable. They said that income not actually received is constructively received and reportable if it's within the taxpayer's control. Further they said that the taxpayer neglected to change his address which was within his/her control. So, the 1099R income should have been reported by the taxpayer in the year we sent the check, along with the withholding. The IRS should have caught it if the taxpayer did not report it and adjusted the taxpayer's return accordingly. If not the taxpayer should file an amended return.

The rollover is a separate and distinct issue from when the distribution is taxable. If the taxpayer meets the requirements of Rev. Proc. 2003-16, there is an exception - the clock actually begins running from receipt of the check (if after 12/31/2001).
But, please read the Rev. Proc. because the taxpayer must meet its requirements. Here's a link: http://benefitslink.com/IRS/revproc2003-16.shtml