Potential tax due on excess rollover in 2005

First, I should say that my wife and I completed a successful 72t plan this year based on information in this forum and Ed Slott’s book. Very few people realize you can withdraw funds from an IRA prior to age 59 1/2. Thank you!

Now, our problem. We were notified by Wells Fargo that my wife’s lump sum retirement distribution in July 2005 was incorrect and they asked for the overpayment back. Due to Statute of Limitations, we declined to send it back and we have just been notified by WF that they will not pursue collecting the overpayment. They did, however, inform us that the excess amount they paid and that was rolled over to my wife’s IRA was not an allowable rollover and may be subject to a 6% excise tax.

Preliminary research suggest the 6 year SOL for tax assessment by the IRS would expire on the 4/15/12 tax filing deadline (6 years after the 4/15/06 filing of our 2005 tax year). But, I just saw something in another post here that said there was no SOL for unallowable/excess IRA rollovers. What is my tax liability here and should I just wait to see if I get anything from the IRS? I do not know what, if any, information Wells Fargo may have provided the IRS on their overpayment (this came up during a Voluntary Compliance Program WF initiated with the IRS).

Thanks for any insights!



First, was the 72t plan from the IRA that received this rollover? That answer can narrow the scenario down quite a bit.



Thanks for the reply, Alan.

The original IRA was about 4 times the amount of the overpayment. That was then broken down into 5 smaller IRA’s invested in different stocks/funds. We set up two of the IRA’s for the 72t with the total of money we needed to allow the income we needed. So, there was an amount that exceeded the overpayment inside the 72t IRA’s as well as much more than the overpayment in the remaining IRA’s that were NOT involved with the 72t.

Also, coincidentally, the amount we withdrew from the 72t (which ended last year), plus what we will withdraw this year is within a couple thousand dollars of the amount of the overpayment. So, we have now paid tax (theoretically) on the total amount of the overpayment. Does that help?



This is a very odd set of facts, one that I have not seen before. But when you consider that the IRS does not understand 72t plans very well, and your plan was part and parcel of the correct solution to this problem, I don’t know whether I would advise you to open up a huge can of worms or wait to see what develops.

In any event, the proper solution to this problem is briefly mentioned on p 49 of Pub 590, “Excess due to incorrect rollover information”. which is exactly what occurred here. The corrective procedure involves two parts:
1) Dealing with the incorrect rollover amount
2) Correcting the excess IRA contribution that resulted. This is where the 72t plan becomes involved because that happens to be how the excess contributions were distributed.

The incorrect rollover amount is supposed to be added to her income (all these accounts are your wife’s, correct?) on an amended return for 2005 showing a reduced rollover amount on line 16b and triggering a tax bill. Under the circumstances the IRS should not charge interest since there is no fault on her part. Since this incorrect rollover amount is being taxed in 2005, it should therefore NOT be taxed as it is withdrawn, which happens to be over the term of the 72t plan. One obvious problem here is that there are various statutes of limitations and the first few years are now closed tax years, but there IS NOT statute for excess IRA contributions. I don’t know how that gets resolved when the solution spans closed and open tax years.

Now, since the rollover IRA was partitioned into 5 IRAs, the excess contribution can come out of any of them, but happen to have come out as part of a 72t plan. What this means is that the annual distributions starting with the first year would reduce the excess contribution for which the 6% excise tax applies and this is reported on Form 5329 for each year. The 6% charges would be based on a reduced amount each year, but it will take this year’s non 72t distribution to completely correct the excess amount. It would then take a detailed explanatory statement to convince the IRS that these distributions were already taxed and should not be taxed again per IRS guidelines. Unfortuneately, that means amending all returns since to reduce the taxes each year to make up for the added tax in 2005. None of this should affect the 72t plan because the correct amount was still taken out per the plan calculations I assume, they are just not included in taxable income again because they were taxed in 2005.

I don’t think there is much of a chance that the IRS would understand this concoction unless you got a top retirement plans expert. And because of all the moving parts, there is probably no way the IRS would come with the same corrective procedure that I have. But it has to be your call whether you want to open the can of worms or wait to see what happens.

Note: I doubt that the IRS compliance team passes employer plan findings to the individual income tax people there, even though they may already have names and SSN of affected employees.
Note 2: You are correct that there is no SOL for excess contributions to an IRA. You create one only be filing a 5329, and showing the excess contribution, but then you have to correct it (which has been done here). Ironically, a 5329 was probably needed to claim the 72t exception code for the penalty waiver, but the excess contribution was not addressed on those. A 72t plan is valid whether the distributions are taxable or not, only the gross distribution matters, so again, this should not affect the 72t plan.

Your call, I guess.



Alan,

Thank you for your very thorough response. Your grasp of, as you called it, a “very odd set of facts” is truly amazing. I agree with everything you said and am leaning towards waiting to see what happens. We take some comfort in the fact that tax HAS been paid on the entire excess amount AND the excess has now been removed from the IRA. One thing I didn’t mention was Wells Fargo said the IRS would waive the 6% excise tax (as part of the VCP with WF) if the money was returned. So, if they didn’t expect it in that case, why should they expect ME to pay it when the mistake was Wells Fargo’s and we just found out about it in Sept. 2011? I guess that’s where a good tax attorney comes in and I have a phone consultation set up for Monday to firm up what we should do.

I WAS glad to learn that if the distributions from the 72t IRA’s do wind up being involved because of amended returns for the affected years, it is the gross distribution that counts towards the 72t, NOT whether tax was necessarily paid (as a result of amended returns).

Since you mentioned the possibility that 5329’s had been used to support the exception noted on our annual 1099-R, I don’t think we’ve ever sent one in. Seems like I remember that being discussed, here maybe, or in some other FAQ’s about 72t plans. I’m thinking someone suggested NOT sending one in UNLESS the IRS challenged your tax return-the reason being, like you said, the IRS doesn’t deal with them a lot. You can then explain the “Exception” noted on the 1099-R distribution with the 5329. I hope that’s not a major screw-up because I really don’t think we’ve sent them in with the 1040’s over the last 5 years.

Again, thank you for your excellent analysis of a somewhat unusual set of facts.



You make a good point about the 6% excise tax waivers, and I forgot to include a suggestion to request a waiver based on the incorrect rollover situation. But your mention that this actually came up between Wells and the IRS probably makes it more likely that the IRS was thinking about the employee reporting end of this. The challenge would be getting some documentation from Wells that you could use to show the examiner of your own return should that be necessary.

With respect to the 5329 as part of your 72t plan, these are only needed if the IRA custodian codes the 1099R with Code 1, and the vast majority of them do that. But if the custodian underwrites the accuracy of your plan they will code the 1099 with a Code 2 instead of 1, then code 7 once your pass 59.5. Just check one of the 1099R forms to see what number was in Box 7. If it was a 2, then there was no need for a 5329. I suspect she was one of the few to get a 2 code or the IRS would have contacted her by now about the 10% penalty.



Regarding the documentation from Wells, I think I have that covered. In their letter explaining they will not pursue recovery, they make reference that they are following requirements of Rev. Proc. 2008-50. In trying to figure out how to request a waiver personally, I ran across a reference to Rev. Proc. 2008-50 that explained that by requesting a waiver under a VCP, the employer could request a waiver for ALL participants affected. I understood it to also say that an individual can request a waiver individually if they can show material error occurred that caused the overpayment, which I can do via documentation I have from Wells. So I think I’m good on getting the 6% excise tax waived. It also mentioned as long as tax was paid as the overpayment was withdrawn, they would not pursue any penalty, so I hope I can support that with my 72t withdrawals. I think these two scenarios satisfy the two parts of the “corrections” you mentioned in your first reply, as required in Pub. 590.

Finally, forgive my brain cramp last night about not filing the 5329’s each year. I did, in fact, confirm when the 72t was set up in 2006 that Box 7 would be coded with a 2. As you suggest, it took me a while to get a hold of someone in my investment company’s home office who understood the importance of it being coded correctly. As such, I have not heard a peep out of the IRS. It really pays to do these things right, and I thank you and Ed Slott again for all the good information.

I may have a little work to do if I hear from the IRS about this, but I believe I am on pretty solid ground at this point.

Many thanks, Alan.



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