Excess contribution to a 401k then rolled over into an IRA

[sunandsand2024]

Hello experts,

I filed my 2023 taxes on April 2024. I included a 1099-R for rolling over my 401k into my Traditional IRA. Few days ago (end of December 2024) I received a 'duplicate' 1099-R for the tax year 2023 from the 401k administrator, where now a portion of the funds got recharacterized as 'not eligible' (about $4,600) . The reason, as I understand it, is that later in 2023, the company I worked for in 2023 went out of business, and their 401k play year was cut short, making some of the contributions not eligible for 2023.  And again since the 401k plan was terminated, I had to rollover the 401k funds into an IRA quickly ( at the end of 2023). Now I find myself with: a) an excess 2023 contribution into a 401k that got dissolved b) a 2023 rollover into an IRA that had a $4600 or so as not eligible funds. Since I just found out, it is too late now to undo these contributions in time to avoid consequences.  So, two questions please:

First:

I understand that I will have to amend my 2023 returns, to include the new 1099-R with the taxable portion. Not fun, but I do not see any other choice. Right? My only question about this part is: why do they call the new 1099-R 'duplicate' and not 'corrected'? TurboTax does ask me if the new 1099-R forms are 'corrected' forms. I am tempted to say 'yes' but technically they have a 'duplicate' box checked and no 'corrected' box that I can find. So are these forms 'corrected' or not? 

Second:

what do I do with the portion rolled over into the Trad IRA? Do I take it out as excess contribution with its earnings? If so, the current IRA administrator will code that entire distribution as due to 'excess contribution for 2023' and the entire amount might become taxable to me again (instead of just the earnings portion'. Even if I tell my current IRA administrator not to apply any tax withholdings, how do I enter in Turbotax that the principal portion that I am taking back had already being taxed by the 1099R corrected/duplicate? Do you recommend a different way to go with regards to the IRA?

Thank you very much

[Opus 17]

What is different about the original and second 1099-R?  Specifically, what is in box 1, 2a, and the code(s) in box 7?  And, if box 1 changed, how much did you actually rollover, the amount in box 1 of the original 1099, the new 1099, or something different?

I believe I know the answers to your other questions, but I don't understand why or how they issued a new 1099-R.  Even if the contributions were ineligible, they were still there, and part of the withdrawal/rollover.  I want to know more about that before I answer the rest. 

@dmertz 

[sunandsand2024]

First, thank you so much for taking the time to read my case.

To answer your question:

The original 1099-R had $190,000 (rounded) in box 1, had $0 in box 2a, code in box 7 was G.

I then received two 'duplicate' 1099-R : one with $185,400 in box 1, $0 in box 2a, G as code in box 7, and another (also coded 'duplicate')  with $4,600 in box 1, $4,600 in box 2a, $0 in box 4, and code E in box 7.

I hope this helps.

Thank you very much for sharing your knowledge.

Andrea

[Opus 17]

I don't fully understand the implications of the code E distribution.  That indicates a return of contributions and attributed earnings that were deemed to be excess due to the plan not being in compliance with some rule.  That $4600 is not eligible for rollover.  (And the plan is supposed to notify you of that in writing.)  Of course, this is so delayed that it is long past the date where you could revise the rollover by the normal means.

What would happen on your amended 2023 return is that you report the two 1099-Rs.  You can say you did a tax-free rollover of the $185,400.  The $4600 that is ineligible for rollover is subject to income tax but the 10% penalty for early withdrawal is not assessed.  Then the regulations say you need to remove the $4600 that you rolled over into the IRA, plus any earnings since the rollover date that are attributed to the ineligible rollover.  The earnings are taxable (but without the 10% penalty) and the $4600 is not taxable since you paid tax as part of the amended 2023 return.  However, I don't know how you actually do this since the deadline for doing this via the normal procedure is over.  (And I think, but am not 100% positive, that the earnings will also be taxable on your 2023 return, even though you won't be able to actually remove the earnings until 2025.)

I'm going to ask for a smarter expert to comment @dmertz , please. 

[sunandsand2024]

Again, thank you so much for your comments.

Indeed, code E distribution is due to a return of contributions and attributed earnings that were deemed to be excess due to the plan not being in compliance, because the plan did not have a full 2023 of 'life' (since my employer unexpectedly went out of business before the end of 2023). So the max annual allowable contributions got prorated (after I had already max-ed them out), and we ended up with an over-contribution. At least this is what I think I understood so far. 

The preliminary course of action you described below makes sense thank you, and indeed I would also love to hear from other super-experts.

As we wait, maybe you can share your opinion on a couple of odd things for me:

1) TurboTax asks if the new 1099-Rs have a 'corrected' box checked. I would expected that they would, as indeed the 1099-Rs are a revision of the previous one. But instead they have a 'Duplicate' box checked (there is not a 'corrected' box available in the 1099-Rs). To me, it seems that are indeed corrected 1099-Rs. Not sure why they called them 'duplicate'. Do you think I should answer 'yes' to the TurboTax question: " Do these forms have the 'corrected' box checked?

2) I suspect that I will have to include in my 2023 amended return the distribution from the IRA of the $4600 and its earnings as excess 2023 contribution.   Is there a way in TurboTax t explain that the the $4600 portion is not taxable since I have included its taxation with the new 1099-R , in the same 2023 amendment??

Thank you thank you.

[dmertz · Accepted solution]

The second code-G Form 1099-R should be shown as a CORRECTED Form 1099-R unless the original was never filed with the IRS, in which case the instructions that came with the second code-G Form 1099-R should have said to ignore the original.  Either way, only the second one of these two is to be used in preparing your amended 2023 tax return.  The code-E Form 1099-R needs to be reported on the tax return for the year of the form and, since this was a return of a tax deferred contribution, it's entirely taxable.

Because the $4,600 was ineligible for rollover, it became an ordinary contribution to your traditional IRA despite how the IRA custodian might have reported it.  If it would not result in an excess regular contribution, you would generally treat it on your amended 2023 tax return as a regular traditional IRA contribution (since, treated as a regular contribution, it would not be an excess contribution).  This might result in the contribution being a nondeductible contribution required to be reported on 2023 Form 8606 Part I.  This would result in not being subject to any excess contribution penalty on a 2023 Form 5329 that would otherwise need to be included with your amendment.

[sunandsand2024]

Dmertz,

thank you so much for taking the time to share your opinion.

Re-reading the short instructions from the 401k custodian that came with the duplicate/corrected 1099-Rs, I read:

"....if you already rolled over this amount to your IRA, you should withdraw the amount plus any earnings as an excess IRA contribution".

Do you think that I should do that and then include the earnings as 'Other taxable Income" for 2023?

thank you thank you

Andrea

[Opus 17 · Accepted solution]

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@sunandsand2024 wrote:

"....if you already rolled over this amount to your IRA, you should withdraw the amount plus any earnings as an excess IRA contribution".

Do you think that I should do that and then include the earnings as 'Other taxable Income" for 2023?

---

You are ineligible for that procedure because it is too late -- it had to be done before October 15, 2024.

What you do now is do what @dmertz said.  You will file an amended 2023 return with the following changes.

1. Report the 1099-R with code G, this is a tax-free rollover.

2. Report the 1099-R with code E, this is treated as a taxable withdrawal subject to income tax, but it is not subject to the 10% penalty for early withdrawal even if you are under age 59-1/2.

3. Report an IRA contribution of $4600.  This is the only legal way to account for the addition of the $4600 to the IRA because it is after the October 15, 2024, deadline for a normal correction.

When you report the $4600 IRA contribution, that could have several different consequences, depending on your income, filing status, and other factors.

a. It might be allowed and tax-deductible, in which case you report it, take the tax deduction, and no further action is needed.

b. It might be allowed, but not deductible.  In this case, you report it, and no further action is needed at this time.  Your tax return will contain a form 8606 reporting the non-deductible contribution.  Because you now have some non-deductible money in a traditional IRA, a small portion of future withdrawals will be tax-free (since you paid tax on the contribution). To document this, you need to keep a copy of form 8606 basically for the rest of your life.  You will need it when you retire and start making withdrawals.

c. It might not be allowed, or only partially allowed.  Your limit for all Roth IRA and traditional IRA contributions in 2023 was $6500, or $7500 if you are over age 50.  IRA contributions are counted separately from workplace retirement plans, but if you did make contributions to an IRA, the extra $4600 might put you over the limit.  Turbotax will ask if you want to remove the excess.  You will say no (because you are past the deadline).  You will be assessed a 6% penalty on the excess contribution, and you will still get a form 8606.

If this happens, it may be possible to correct the problem on your 2024 tax return to avoid future penalties, depending on your situation.  The correction would have to be made before April 15, 2025.  So prepare your 2023 amended return first, see what the result was, and then we can talk about anything you might need to do for 2024.  

[sunandsand2024]

Wow. I have never reached out  to an online community for help, and I am in owe.

Thank you for your help Opus and Dmertz.

Opus, based on what you wrote, I think I will be in the b) scenario (income limit, but no other IRA contributions).

Bear with me, I have two ask you two more questions:

1) The letter with the instructions that I quoted is dated December 2024, (same date of the received the revised 2023 1099-Rs). The letter is from custodian (Vanguard) for the defunct 401k plan. I am realizing now that in December 2024 they advise me to take out that excess distribution from the IRA, when effectively I can't do that anymore???? Isn't that surprising?

2) do you also agree that I should mark the 1099-R as 'corrected' , in spite of the fact that they came with a 'duplicate' box instead? In the same letter of instructions, I read "...in accordance with IRS guidelines, Vanguard will issue revised 1099 Forms...". Well, if they are 'revised' ..they are 'corrected'. I wonder if they did not use the word 'corrected' to make their life .....easier ?

thank you thank you

[Opus 17]

@sunandsand2024 

1. I suspect it is boilerplate (cut and paste) language that does not take into account the timing.  The failure of a plan to meet validation testing is probably not all that uncommon and your plan is not the only one that Vanguard had to correct.  

2. I would follow @dmertz 's recommendations on how to report.

[sunandsand2024]

Thank you both.

I will work on it in the next days and report back if I get stuck.

Again, thank you.

[dmertz]

As Opus 17 mentioned, Vanguard's instruction appears to describes the procedure for obtaining a return of contribution before the (extended) due date of your 2023 tax return.  Since it's now past October 15, 2024, the deadline for doing than, I'm not sure that you can treat the $4,600 as an excess contribution unless some or all of it would be an excess contribution when treated as a regular personal traditional IRA contribution.

Since it's now 2025, treating the $4,600 as an excess traditional IRA contribution would subject to to a 6%, $276 penalty on your amended 2023 tax return and again on your 2024 tax return.  If the $4,600 would not be an excess contribution for 2023, I think that the best approach would be to report it as a regular personal traditional IRA contribution on your amended 2023 tax return and be done with it.  (If your 2023 MAGI for the purpose would make it a nondeductible contribution, you'll need to track that on Form 8606 going forward.)

Oh, and given how late the replacement code-G Form 1099-R came, it has to be a CORRECTED form since Vanguard would have sent the original to the IRA long ago.  Vanguard should have marked the CORRECTED box on the form.