Life and Death Planning for Retirement Benefits

Chapter 2: Income Tax Issues

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contribution and income thereon in early 2011. Here is how she will report these transactions on her tax return: $300,000 distribution from the inherited 401(k) plan in 2010 (this is includible in her income in 2010, but is not subject to the 10% penalty because the penalty does not apply to death benefits; see ¶ 9.4.01 ); additional income of $12,000 (the earnings on the contribution) reportable in 2010 and subject to the 10% penalty in 2010 (see “D” above); and $5,000 contribution to her own IRA for 2010. Armande Example: Armande, age 45, is eligible to contribute $5,000 to a traditional IRA in 2010. By mistake he contributes $9,000. He has made an excess contribution of $4,000. By the time he discovers this error, in early 2011, the $4,000 excess contribution has already generated $3,000 of “net income attributable thereto” ( ¶ 5.6.02 ) due to Armande’s spectacular investment success. To avoid a six percent excess contribution penalty for 2010 ($240), he would have to withdraw the $4,000 excess contribution and the $3,000 of “earnings” thereon ...but the earnings would be subject to income tax and to the 10 percent penalty on “early distributions” (see “D” above) because Armande is under age 59½. So he would have to pay a $300 penalty to avoid a $240 penalty! He decides to pay the excess contributions penalty of $240 for 2010, leave the excess contribution in the IRA, and treat the 2010 excess contribution as part of his $5,000 “regular” IRA contribution for 2011. In 2011 he is eligible to contribute up to $5,000 to an IRA from his compensation income, so the $4,000 excess contribution carried over from 2010 will “absorb” most of his 2011 contribution. It sometimes happens that a plan administrator pays benefits to the wrong person. For example, an IRA provider might distribute the account to beneficiaries based on an outdated beneficiary designation form, overlooking a more current designation that named different beneficiaries. Or a plan administrator gets two employees with similar names mixed up and pays Employee A the benefit that actually belongs to Employee B. When this happens, who is supposed to report the distribution as income? The author hopes that someone else will write a full scholarly treatment of this topic; in the meantime, the following brief comments may be helpful. It appears that generally the distributee must report the payment as income, even though he/she is not entitled to it. For example, when a qualified plan makes an erroneous payment, the distributee must report the payment as income unless it is paid back to the plan in the same taxable year; the distributee can get an itemized deduction for paying the money back in a later year. See Rev. Rul. 2002-84, 2002-2 CB 953 and CCA 2013-13025. § 1341 provides the tax deduction for restoring an erroneous payment; this deduction is not subject to the usual two-percent “floor” on miscellaneous itemized deductions. § 67(a) , (b)(9) . A thief who steals from someone’s IRA must report the stolen money as income, and presumably the IRA owner or beneficiary does not have to report the stolen distributions as income. See Andrew W. Roberts , 141 T.C. 569 (2013), in which a wife (who performed all investment and tax work for the couple) embezzled from her husband’s IRA and filed forged tax returns in his name, stealing his tax refund as well as his IRA, while he was away on military service. The court found husband not liable for income tax on the distributions; since husband Distributions made in error: Wrong amount, person, etc.