401k Excess Contribution Late Withdrawal

[kilter]

Thanks @dmertz .  So I amend now and pay the additional income on that excess -- even though I can't withdraw it, it seems -- and then I pay taxes on it again when I am allowed to withdraw it.  That makes sense.  Thanks.

"the excess contribution does not add to your after-tax basis in the plan"

Why not?  I guess the part that is still catching me up is that the investment basis of that additional contribution could end up outpacing the penalty over the course of the investment, I think?  So couldn't I end up "cheating" the system by being allowed to have invested more up front due to excess contributions and letting it sit there for 15 years?  Especially if I wait until retirement age to withdraw?  Or am I not thinking about it correctly?

[dmertz]

Why not?  Because the IRS says it doesn't; the IRS says the money is subject to double taxation.  If it did add to your basis you wouldn't be paying taxes twice on this money.

From Treasury Decision 8357, IRS 1991-2 C.B. 181:

If an individual defers more than the maximum for a taxable year under plans of two or more unrelated employers, generally none of the plans is disqualified due to the excess. The individual may not, however, exclude the excess deferrals from gross income. Also, unless the excess deferrals are timely corrected under section 402(g)(2), they are taxed again when distributed from the plan, since they do not increase the employee’s investment in the contract under section 72.

[kilter]

This link/context is exactly what I was looking for.   Thank you!

[kabboston]

@DanaB27 thank you for all the detail you provided, BUT sorry a question.  I am in the situation as the poster, changed jobs and over contributed.  

I have already filed with my administrator for a refund of the excess amount, and they will be withholding taxes.

I understand your instructions, but I think this conflicts with what the Turbo tax told me when it told me I had an excess deferral.  It said to report it as a 1099-R (if I was going to receive before 4/15) and in box 7 select P to indicate this is a 2023 Form 1099R.  I came here because P in box 7 was talking about 2021, not 2022 and I was confused.   Below is what Turbo tax had under what steps do I need to take:

1. Report the excess deferral on your 2022 return in the Income section for Retirement Plans and Social Security whether or not you received a Form 1099-R before you file your return. Enter as much information as you can. Report the excess deferral amount in boxes 1 and 2a, and use code P in box 7. Indicate that this is a 2023 Form 1099-R.

2. In 2023, you will probably receive two Forms 1099-R. One reports the excess deferral amount. The other reports the earnings on the excess deferral. Enter both of these forms in your 2023 return, and we'll only add the earnings to your 2023 income.

I think I am trusting you more than them 🙂  But any guidance would be appreciated.  

Thanks

Kimberly 

@DianeW777 

[LindaS5247]

If you received a 2022 401(k) excess deferral distribution in 2023, you'll receive a 2023 Form 1099-R with a distribution Code P in box 7; however, it must be included on your 2022 tax return. You have two options to do that:

1. Wait until next year when you receive the 2023 Form 1099-R and amend your 2022 tax return
2. Report it now on your 2022 return and ignore the 2023 1099-R when it comes next year
   • If your 2023 Form 1099-R has an amount in box 4, Federal tax withholding and/or box 14 State withholding, then you must enter it on your 2023 tax return. The 2023 Code P won’t affect your return, but the withholdings will be applied to 2023.

Select your choice below and follow the instructions.

Amend your 2022 tax return:

Sign in to TurboTax, scroll down, and open Your tax returns & documents

1. Select 2022, then Amend (change) return, then Amend using TurboTax Online
2. On the OK, let's get a kickstart on your 2022 amended return screen, select Adding or updating a tax form then Continue
3. On the Which one of these forms do you need to add to your return? screen, select 1099-R then Continue
4. Continue through the screens and answer all the questions

Report it on your 2022 tax return before filing:

If you haven’t filed your 2022 return yet and want to report a 2022 excess 401(k) deferral that was distributed in 2023:

1. Sign in to TurboTax and open or continue your return
2. Go to Wages & Income under Federal
3. Under Less Common Income, select Start or Revisit next to Miscellaneous Income, 1099-A, 1099-C
4. Select Start next to Other income not already reported on a Form W-2 or Form 1099
5. Answer Yes to Did you receive any other wages?, then Continue
6. Continue until you get to the Any other earned income screen. Answer Yes and select Continue
7. On the Enter Source of Other Earned income screen, select Other and Continue
8. On the Any Other Earned Income screen, enter 2022 Excess 401(k) Deferrals for the description, enter the amount, and select Done

For Tax Year 2023:

Your 2023 Form 1099-R form will be issued reporting the excess 2022 401(k) deferral you received as a distribution in 2023.

• You can ignore a Form 1099-R with code P in box 7 if you reported the excess as described above in 2022
• But, the earnings on Form 1099-R with code 8 in box 7 should be reported in 2023

If you don't take out the excess amount by the due date, you're taxed twice on the excess deferral left in the plan. This happens once when you contribute it and again when you receive it as a distribution. You can't include the excess amount in the cost of the contract even though you included it in your income.

[kilter]

Hi @LindaS5247 , thanks for the helpful response here.  I posted earlier in this thread thinking I would not get the excess deferral distribution in time, but my financial institution was able to process it before 4/15 even though I applied after their deadline. 

I already filed my 2022 return without reporting the excess deferral distribution because I wasn't planning to get it in time, so I'm trying to decide whether to amend my 2022 return now or wait until 2023 when I do my taxes then.  Could you help me understand the tradeoff between amending now versus waiting until next year?  Are there any risks to waiting?  Like, am I at a larger risk of an audit since there is the unresolved excess contribution in my 2022 return filing if I wait?

Thanks!

[dmertz]

Your 2022 tax return should have already included the excess deferral as miscellaneous income, so it's not clear what would you need to change by amending.  Any investment gain that accompanied the distribution of the excess deferral will be taxable on your 2023 tax return.

[JK103]

I am in similar situation but I realized that I have excess 401K on 4/15 so I won't get it back before deadline. My amount is small - ~850. I am including that amount in my miscellaneous for 2022 so nothing to amend there. What would be a suggestion now. Should I ask to return it now which means I will pay for that amount again tax in 2023 + 10% penalty or should I wait for my retirement (>15 years remaining) and then withdraw. If I withdraw after retirement, from what I read in other replies, I will have to pay tax on this 850 in addition to anything I will pay on the amount I earn on top of this. I just won't pay 10% penalty. Any suggestions on what is better to do?

[Cynthiad66]

Per our expert DanaB27, you will have to add the excess deferral for 2022 to your wages with these steps:

1. Login to your TurboTax Account 
2. Click "Wages & Income" (under Federal) on the left side of your screen
3. Scroll  down to "Less Common Income" and click "Show More"
4. Scroll down to "Miscellaneous Income, 1099-A, 1099-C" and click "Start"
5. Select "Other income not already reported on a Form W-2 or Form 1099" and click "Start"
6. On the "Did you receive any other wages?" screen answer "Yes" and click "Continue"
7. Continue until you get to the "Any other earned income" screen, answer "Yes" and click "Continue"
8. On the "Enter Source of Other Earned income" screen select "Other" and click "Continue"
9. On the "Any Other Earned Income" screen enter "2022 Excess 401(k) Deferrals" for the description, enter the amount and click "Done".

Please be aware, if you do not take out the excess amount by April 15th, then you are taxed twice on the excess deferral left in the plan.  This happens once when you contribute it with the steps above and again when you receive it as a distribution. You can't include the excess amount in the cost of the contract even though you included it in your income.

Please see Pub 525 for additional information.

Excess contributions must be included as income for the year in which the contributions were made. If the excess contributions haven't already been claimed in that year, the return will need to be amended to include the excess distribution as income.

TurboTax will calculate your MAGI and determine whether you've made an excess contribution. If this happens, you'll be subject to a 6% tax penalty on the excess amount for every year that it stays in the account.

[JK103]

That is weird, one of the message above said wait till 59.5 to take it out, no where it said I will be taxed 6% every year but it said I will be taxed only in the year I take it out? Is that not the case?

[dmertz]

Cynthiad66 is incorrect about there being any 6% penalty.  Cynthiad66 is confusing this with an excess Roth IRA contribution.

[JK103]

Thanks, is it better then to wait till I retire (~15 more years) or should I remove it now only?