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federal tax withheld on corrective distribution?

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  • federal tax withheld on corrective distribution?

    I mistakenly had an excess salary deferral situation in 401k accounts after switching jobs in 2020, which resulted in an excess of employee contributions. I contacted my current employer's 401k custodian and they issued a corrective distribution of the excess salary deferred + the earnings from that excess deferral. I'm planning on adding the excess deferral back into my income on my 2020 taxes so that I pay my marginal rate on this amount. I will receive 1099-R's next year to deal with taxation on the earnings, which are classified as 2021 income.

    I'm fairly certain all the above is correct. BUT,

    The 401k custodian withheld federal tax on the corrective distribution. In the instructions for this scenario, the IRS website states
    Corrective distributions of excess deferrals are not subject to federal income tax withholding or social security and Medicare taxes.
    So I think they need to give me a 2nd check to return the withheld taxes to me.

    I'm worried that since they messed this up once, they may mess up the 1099-R's if I ask for the withholding back. So, should I:
    1. Ask for withheld tax back. Hope they don't list any withheld tax on the 1099-R's in 2022
    2. Let them keep the withheld tax, assume the 1099-R will document this, and receive the money back in my 2021 tax refund

  • #2
    I’m writing this from home w/o checking on client corrective dist tax forms, but I fail to see why fed w/h w/n/b appropriate on a corrective distribution, as it is taxable income. I think 10% is typical.
    Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087


    • #3
      I am definitely no expert in these sorts of matters (this would be the first time I have received any distribution from a tax-deferred account). But I have read about this issue and I believe that so long as you receive the corrective distribution by April 15, no taxes should be withheld. If you get around to double checking your references, I'm interested to know what the right answer is.

      My references:
      IRS Form 1099 Instructions under Corrective Distributions, Excess deferrals
      IRS 'Issue Snapshot'


      • #4
        I agree that it’s probably IRS guidance (sorry, have not researched) but I don’t see much point in making an issue over the withholding. No harm, no foul - it’s a minor amount that will be taken care of in the tax filing, not a lost expense. Ifaurem were a client, I’d advise to just get on with it.
        Working to protect good doctors from bad advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087