401(k) excess deferral treatment

[buggfixer]

I over-contributed to my 401K plan for tax year 2022 but caught the issue early in 2023. My plan administrator has said that the 1099R will be issued for tax year 2023, not 2022. Since I notified my plan admin early enough, I can either include the excess deferral in my 2022 return right now as income or amend my 2022 return once I receive the 1099R months after 4/18/23.

If I choose to amend, would the excess deferral be taxed again as income for tax year 2023?

Had I notified my plan admin of the excess deferral after 4/18/23, that amount would be taxed in both years, but with the quick discovery of the issue, I want to be sure of any pitfalls of the amendment option.

[MinhT1 · Accepted solution]

You should report the excess contribution in 2022. This excess will be added to Wages to be taxed. The reason is that the excess had been wrongly excluded from taxation on your form W-2 in 2022. This excess will not be taxed again in 2023. Only the gain realized on the excess (if any) will be taxed in 2023.

This is how you report the excess contribution.

Report excess salary deferrals (excess 401k contributions) returned to you after the end of the tax year but by April 15th of the following tax year on your 1040.  Do not create your own 1099-R for this situation.

Pages 10 and 11 of IRS Pub 525 under Excess deferrals (the IRS term for 401K contribution is deferral) tells us: 

If your deferrals exceed the limit, you must notify your plan by the date required by the plan. If the plan permits, the excess amount will be distributed to you. If you participate in more than one plan, you can have the excess paid out of any of the plans that permit these distributions. You must notify each plan by the date required by that plan of the amount to be paid from that particular plan. The plan must then pay you the amount of the excess, along with any income earned on that amount, by April 15 of the following year. You must include the excess deferral in your income for the year of the deferral. File Form 1040 or 1040-SR to add the excess deferral amount to your wages on line 1a.

What you earned will be covered by a 1099-R for the following tax year and will be entered then as a normal 1099-R.

Below is how to do this in TurboTax:

1. Click on Federal in the left-hand column, then on Wages & Income
2. Continue and locate the section Less Common Income
3. Select Miscellaneous Income and click Start
4. Select Other income not already reported on a Form W-2 or Form 1099 and click on Start
5. Answer the question "Did you receive any other wages?  Yes
6. Click through the questions till you get to Any Other Earned Income
7. Answer Yes to Did you earn any other wages?
8. Indicate Other as Source of Other Earned Income and click Continue
9. For the description enter "2022 Excess 401K Deferrals" and click on Done

[buggfixer]

Thank you for the detailed answer! Appreciate it.

[Opus 17]

I believe the excess deferral will be automatically detected by Turbotax from your W-2s and automatically added back to your taxable income.  Don't manually add back the income because you will be double-taxed.

@dmertz ??

You could leave the money in the account with no penalty.  The problem is you would pay tax now (because it's excess) and you pay income tax again when you retire and withdraw the money (because that's how 401k plans are taxed.)  Since you have to pay tax on the money no matter what and don't get the tax-free treatment, the idea is you might as well withdraw it and spend it or invest it some place else.  '

But I'm pretty sure the add-back is automatic. 

Then in 2023, you will get a 1099-R for the distribution with code P, which means, "corrective distribution that was taxable in a prior year."  You report it on your tax return, but Turbotax will know not to include it in 2023 taxable income because of code P. 

[Edited by original author]

[dmertz]

TurboTax warns about suspected over contributions, but otherwise does nothing about it.  It's up to the user to add the excess deferral to income, in this case, 2022 income.

Note that the distribution was required adjusted for investment gain or loss while the excess was in the account and any gains accompanying this distribution in 2023 would be taxable on the 2023 tax return, generally reported on a separate From 1099-R.

[Opus 17]

---

@dmertz wrote:

TurboTax warns about suspected over contributions, but otherwise does nothing about it.  It's up to the user to add the excess deferral to income, in this case, 2022 income.

I find that bizarre.  It would seem to defeat the accuracy guarantee.  Thanks. 

[Wolf43]

I made the same 401K excess contribution error after switching jobs.  I caught the error before filing and want to take care of it as much as possible in the 2022 tax filing.  Is it best to get a revised W-2 from my current employer, or do I just report the excess 401K contributions in my 2022 Turbo Tax filing  as you said, and then report any gain realized on the excess contribution in 2023 (using the 2023 Fm1099 that I should be sent by the 401K custodian)?

[DanaB27]

You can just report with the steps mentioned above by Tax Expert MinhT1.

If you receive the distribution of the excess deferral and earnings by April 15th then please note for the Tax Year 2023 tax filing due April 15, 2024: 

• 2023 Form 1099-R with code P in box 7 can be ignored if you reported the excess as described above in 2022. 
• The earnings on 2023 Form 1099-R with Code 8 in box 7 should be reported in 2023.

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 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.

@Wolf43 

[PeterB-2022]

---

@DanaB27 wrote:

You can just report with the steps mentioned above by Tax Expert MinhT1.

If you receive the distribution of the excess deferral and earnings by April 15th then please note for the Tax Year 2023 tax filing due April 15, 2024: 

• 2023 Form 1099-R with code P in box 7 can be ignored if you reported the excess as described above in 2022. 
• The earnings on 2023 Form 1099-R with Code 8 in box 7 should be reported in 2023.

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 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.

@Wolf43 

---

If I understand that correctly, to be taxed twice will only happen when I've entered and already filed to IRS of the excess amount in Turbotax for tax year (2022) with "2022 Excess 401(k) Deferrals" under the "Any Other Earned Income" section, but the excess amount is removed after April 18th (actual deadline) ?

What's the solution for that ? Does that mean we have to amend the tax return ?

What if I filed a tax extension which is good until Oct 15th and I plan to file the 2022 tax to IRS until my 401k over contribution is corrected even if that's fixed after April 18th, do I still pay twice tax ? 

[DanaB27]

Yes, 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. Please be aware this is a separate deadline from the filing due date. Any distribution of the excess deferral after April 15th is a regular taxable distribution from the 401(k). You cannot claim that you already paid taxes on the amount. 

The solution to avoid being taxed twice on a 2022 excess deferral is to make sure it was removed by April 15th, 2022.

If you cannot get the excess deferral distributed by April 15th then you might want to leave the excess deferral in the account until you are 59 1/2 (if your plan allows it) to avoid the 10% early withdrawal penalty. 

@PeterB-2022 

[smart_indian]

Where would the turbotax include the excess distribution received in 2023 for the year 2022 in the 1040 form ? Will turbotax file Schedule 1 and include in the other income ? 

I am asking because it is mentioned in the deferral refund check to include the pre-tax amount to Line 7 (which is capital loss or gain) column. Reference: https://www.hr.upenn.edu/PennHR/benefits-pay/saving-for-retirement/contributions/excess-deferrals/

Situation: I made excess contribution in 2022 and received the excess deferral in Feb 2023 but the 1099-R willl be issued in Jan 2024 for the year 2023. I want to know how turbotax treats the excess deferral in the income calculation. Is it Schedule 1, line 8z (since it mentions only allocable loss in 1040 instructions) or not ? 

my question is: "where is the excess deferrals included ? "

[Mike9241]

You cite PHR but is that who you got the refund from or are you just citing that as an example. The reporting it cites seems inaccurate. a refund of an excess employee deferal should not be capital gain. the original deferral reduced your taxable wages so a return should be ordinaruy income  Also reporting loss on line 21 on the 2022 form 1040 does not make sense. it would seem the line numbers are referncing the 2018 form. 

This is from IRS website

Timely withdrawal of excess contributions by April 15

• Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
• Earnings are taxable in the year they're distributed.
• There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-elective-deferrals-werent-limited-to-the... 

this is from IRS PUB 525

You should receive a Form 1099-R for the
year in which the excess deferral is distributed
to you. Use the following rules to report a corrective distribution shown on Form 1099-R for
2022.
• If the distribution was for a 2022 excess
deferral, your Form 1099-R should have
code 8 in box 7. Add the excess deferral
amount to your wages on your 2022 tax return

 create a dummy 1099-R use employer name and EIN box & use code 8 in box 7 and report in boxes 1 and 2 the amount of the excess. this will show up on line 1h on the 1040. 

[dmertz]

The amount of the excess deferral goes on line 1h of your 2022 Form 1040 as Other earned income.  You do this in TurboTax by going to Wages & Income -> Miscellaneous Income, 1099-A, 1099-C -> Other income not already reported on a Form W-2 or Form 1099.  Answer Yes, you received other wages, Yes, you earned other wages, Other, then enter the amount of the excess deferral.

Because the corrective distribution occurred in 2023, Pub 525 indicates that the loss can be claimed on your 2023 Schedule 1 line 8z as "Loss on Excess Deferral Distribution," nowhere on your 2022 tax return. 

[Geppo]

Thank you for the detailed solution.

I have a follow up question: I noticed the excess deferral (for TY 2022) before April 2023, and reported it to the plan administrator, including the amount of the excess deferral. The plan administrator gave me a distribution for a slightly lesser amount, due to "market fluctuations" (their words). For my 2022 taxes, when I follow your procedure to report the distribution, should I report the over contributed (higher) amount, or the actually received (lower) amount? Do I need to report the difference in some way?  Also, when doing my 2023 taxes, should I claim the difference as a loss?  Thank you!

[dmertz]

Don't confuse the amount of contribution returned with the amount distributed.  To accomplish the return of the particular amount, a smaller amount was distributed due to the loss in value in the account during the computation period.  Your excess contribution was still the higher amount and was the amount of contribution returned.

For example, if you contributed an excess $100 and the value of the account dropped 10% between the time the $100 was deposited and the corrective distribution was made, a distribution of $90 accomplishes a return of the $100 contribution.

IRS Pub 525 says that you can claim the difference as a loss by entering a negative amount on Schedule 1 line 8z as "Loss on Excess Deferral Distribution."  That entry is made in TurboTax under Wages & Income -> Less Common Income -> Miscellaneous Income, 1099-A, 1099-C -> Other reportable income.