Tax treatment of lump sum distribution

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Tax treatment of lump sum distribution

Postby FinancialDave » Wed Jan 16, 2013 1:04 pm

My question does not seem to be an easy one to answer as multiple calls to my employer and the IRS have turned up conflicting information (which I guess is not surprising :( )

I had both a pension account which was totally funded by my employer and another voluntary plan from the same employer that was totally funded by me. When I retired I took a lump sum distribution of the voluntary plan (which was mostly my money) and the other plan pays out the normal monthly pension. Two 1099-R's were issued but my contribution is now shown on the 1099-R attached to the monthly payments and thus they are recovering the cost over the life of the pension. My first contact with the IRS before the 1099-R's were issued indicated that the lump sum distribution was essentially a separate worksheet and thus my cost recovery would all occur in 2012 with the lump sum distribution. I cannot see anywhere in pub 575 where it would allow the employer to combine the two plans and put my contributions on essentially the wrong 1099-R, though they claim this is correct and has been "forever." The original IRS agent seemed to indicate that two "worksheet A's" would need to be filed out, but it won't help if I can't get my contributions on the correct 1099-R.

I'm not sure if I am wasting my time, but the hit to this years taxes is significant if I have to take the whole lump sum as taxable this year.

Any tax experts out there??

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Re: Tax treatment of lump sum distribution

Postby Alan S. » Wed Jan 16, 2013 4:01 pm

Sounds strange. What does the other 1099R show, and is there any account # on the bottom that shows on both 1099R forms? Was there 20% mandatory withholding on any earnings accrued in the voluntary plan?
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Re: Tax treatment of lump sum distribution

Postby FinancialDave » Wed Jan 16, 2013 5:12 pm

Alan S. wrote:
Sounds strange. What does the other 1099R show, and is there any account # on the bottom that shows on both 1099R forms? Was there 20% mandatory withholding on any earnings accrued in the voluntary plan?


There are unique account numbers on each 1099-R (actually 3 character name) and yes 20% was withheld from the lump sum.

Company essentially says these accounts should be combined as it is one plan with lump sum 100% taxable (or more correctly says this is what IRS told them.) The normal pension plan shows what you would expect for a pension with some employee contributions - in other words all the contributions are shown on this 1099-R, but strangely the withheld tax is shown on the other 1099-R.

EVEN, if that is true, when I read pub 575 (2011) p 15 has a paragraph called SINGLE-SUM IN CONNECTION WITH START OF ANNUITY PAYMENTS, which essentially seems to say that this lump-sum should be treated as happening before the start of the annuity payments, which would allow you to allocate part of the cost to the distribution.

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Re: Tax treatment of lump sum distribution

Postby HueyLD » Wed Jan 16, 2013 5:37 pm

FinancialDave,

Is your former employer the federal government and is the supplemental policy "CSRS Voluntary Retirement System?"
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Re: Tax treatment of lump sum distribution

Postby FinancialDave » Thu Jan 17, 2013 4:53 pm

HueyLD wrote:FinancialDave,

Is your former employer the federal government and is the supplemental policy "CSRS Voluntary Retirement System?"


No, actually it is GE and they call it PPA/VPA - not much different thought in the are of being able to get a resolution from that end.

I did notice something in one of the IRS pubs called REQUESTING A RULING ON TAXATION ON AN ANNUITY, though it says something about a charge, I am wondering if it would be worthwhile and if they would really dig into the details of the employers plan to give what at least should be a fair ruling - or if they are just going to look at the 1099-R's and make the determination from that??

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Re: Tax treatment of lump sum distribution

Postby Alan S. » Thu Jan 17, 2013 7:17 pm

I can't say I understand what they are doing, but considering the sheer size of GE and long standing history of these PPA/VPA accounts, there is no chance that what they are doing is incorrect unless there is a unique screw up with your own personal account. Remember, GE's army of tax lawyers has resulted in them paying -0- federal income taxes for a period of time.

As a retiree, you should be able to get a more thorough explanation than what I pulled up here:
http://www.uawlocal647.org/upload/2011- ... 20Pres.pdf

While it is clear that both your PPA and VPA contributions were made after tax, the link shows the lump sum distribution as being fully taxable, a glaring inconsistency. It appears that your basis has been integrated into your "regular pension", which is actually consistent with what the link and your 1099R forms indicate.

I don't think there is any benefit to asking for help from the IRS. Does the company anywhere mention that you must use the SIMPLIFIED method that might change the taxable amount they are showing on the regular pension 1099R?

Tax relief for the current year appears available by doing a 60 day indirect rollover of your proceeds, but you would have to replace the 20% withholding, which is another indication that you can roll this over because mandatory 20% withholding only applies to ERDs (eligible rollover distributions). If you had an option of doing a direct rollover of this portion, it would have eliminated the withholding, but you still have 60 days to roll the balance (better with withholding replacement than without) to a TIRA account. There would be no basis in that rollover since GE appears to have transferred your basis into the regular monthly pension. This is not normal, and therefore GE should provide a clear and consise explanation, but apparently have not done that.

This is entirely different than the CSRS VCP, which allows active employees to make large contributions and convert them almost tax free. Perhaps someone viewing this is a GE Retiree who can provide a better explanation. I'm sort of guessing from the tidbits available at various sites, so just take this as preliminary speculation over what is going on here. Investigate further, but don't let that 60 days expire. If you do the TIRA rollover and later find out that this amount somehow includes basis, you can report the basis on your next 8606 to prevent double taxation.

Last question - what small portion of your total basis appears to be recovered on the other 1099R?
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Re: Tax treatment of lump sum distribution

Postby FinancialDave » Thu Jan 17, 2013 7:57 pm

Alan S. wrote:I can't say I understand what they are doing, but considering the sheer size of GE and long standing history of these PPA/VPA accounts, there is no chance that what they are doing is incorrect unless there is a unique screw up with your own personal account. Remember, GE's army of tax lawyers has resulted in them paying -0- federal income taxes for a period of time.

I would tend to agree


While it is clear that both your PPA and VPA contributions were made after tax, the link shows the lump sum distribution as being fully taxable, a glaring inconsistency. It appears that your basis has been integrated into your "regular pension", which is actually consistent with what the link and your 1099R forms indicate.

The one issue may be that the PPA half of the fund is actually not voluntary, above a certain salary 3% of your after-tax income goes into this bucket


I don't think there is any benefit to asking for help from the IRS. Does the company anywhere mention that you must use the SIMPLIFIED method that might change the taxable amount they are showing on the regular pension 1099R?

NO


Tax relief for the current year appears available by doing a 60 day indirect rollover of your proceeds, but you would have to replace the 20% withholding, which is another indication that you can roll this over because mandatory 20% withholding only applies to ERDs (eligible rollover distributions). If you had an option of doing a direct rollover of this portion, it would have eliminated the withholding, but you still have 60 days to roll the balance (better with withholding replacement than without) to a TIRA account. There would be no basis in that rollover since GE appears to have transferred your basis into the regular monthly pension. This is not normal, and therefore GE should provide a clear and concise explanation, but apparently have not done that.

I investigated this option, but it would have converted the whole lump sum into 100% taxable on withdrawal from the IRA later, and at least from what I understood from GE, I would have lost my cost basis and had to pay tax on the money twice. Now that I see the 1099-R's I am wondering if that explanation was wrong and I would have still gotten my contribution shown on the second 1099-R.


This is entirely different than the CSRS VCP, which allows active employees to make large contributions and convert them almost tax free. Perhaps someone viewing this is a GE Retiree who can provide a better explanation. I'm sort of guessing from the tidbits available at various sites, so just take this as preliminary speculation over what is going on here. Investigate further, but don't let that 60 days expire. If you do the TIRA rollover and later find out that this amount somehow includes basis, you can report the basis on your next 8606 to prevent double taxation.

Last question - what small portion of your total basis appears to be recovered on the other 1099R?
There calculation is to recover my basis over 25.5 years, so it would seem the answer is about 4%



Unfortunately the deal is done, as my retirement date was in April.



What keeps me from using the Simplified Worksheet. This does not seem like something the employer would specify. In all my talks with the IRS, they were saying the Simplified Worksheet is the way to calculate this. My next step was to review the instructions.






I guess one final question would be -- when would a lump-sum distribution ever be 100% taxable, when after tax money is involved?

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Re: Tax treatment of lump sum distribution

Postby HueyLD » Thu Jan 17, 2013 10:28 pm

FinancialDave,

On page 19 of the pdf file link provided by Alan above, it states as follows:

"Monthly Pension is taxable except for return of your contributions
Withdrawal of PPA/VPA either in Lump Sum or Partial - fully taxable"


I doubt that anyone would think that GE has not followed the IRS rules. AFAIK, partial withdrawals are treated as coming out of earnings first for certain pension plans. It appears that companies have different pension plans and each may have its own distribution rules.

I asked you earlier if you retired from the federal government because the fed's voluntary contribution plan can be withdrawn in lump sum without being looped into the regular civil service retirement pension.

Hopefully you have set aside some of the lump sum money for your tax bill.
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Re: Tax treatment of lump sum distribution

Postby FinancialDave » Fri Jan 18, 2013 3:22 am

Huey,
The IRS helps you eliminate the tax problem by demanding 20% be withheld from ANY lump sum withdrawals. That is not the issue, I just don't see the ruling that allows the cost to be recovered over the life of the pension in a situation like this. The earnings part of the distribution is only 1/3 the size of the distribution, unless of course you are referring to the earnings of the companies pension plan -- which I have no idea, but I am not sure how that would be known.

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Re: Tax treatment of lump sum distribution

Postby johngaltlives » Fri Apr 05, 2013 4:05 pm

Hi. Just curious if anything more happened with this. I have a similar situation, and I'm curious about whether this could be challenged based on classes (e.g., if one could show that the policy, though within IRS rules, would unfairly penalize those with less invested or at lower income/pension levels). Just a thought. It also contradicts the policies of most other companies regarding these plans, and by commingling the funds and adding the basis into the overall plan, it results in immediate double-taxation for those who withdraw their after-tax contributions early. I spoke with a representative about it months ago, and he said it was a penalty enforced by the IRS. I told him that it's not a penalty, but an unfair way to treat the basis. He then referred to Pub 575, and I told him I've read it, and if I read it as it's written, that money should be non-taxable, that nothing in there says it's as GE has it. It's done that way only so GE can keep as much of the tax benefit within the fund as possible, to the detriment of the timing of those in the fund. The whole reason I called in the first place was to tell them they had an error in my statement, and that they had switched the non-taxable portion and the taxable portion labels. Now I understand that's not the case at all. Even though another post says it's likely that this is within the regs (I'm sure it would be), I still think one could pursue an IRS letter ruling, or something similar, to establish that companies don't have the discretion to treat the basis that way. If you put the money in, after tax, and then you are drawing it out, that money can't be other money in the fund, that was put in pre-tax, but of the exact amount. That's an arbitrary switch done solely for the benefit of the plan administrator, not for the participants.
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Re: Tax treatment of lump sum distribution

Postby FinancialDave » Sat Apr 06, 2013 2:50 pm

johngaltlives wrote:Hi. Just curious if anything more happened with this. I have a similar situation, and I'm curious about whether this could be challenged based on classes (e.g., if one could show that the policy, though within IRS rules, would unfairly penalize those with less invested or at lower income/pension levels). Just a thought. It also contradicts the policies of most other companies regarding these plans, and by commingling the funds and adding the basis into the overall plan, it results in immediate double-taxation for those who withdraw their after-tax contributions early. I spoke with a representative about it months ago, and he said it was a penalty enforced by the IRS. I told him that it's not a penalty, but an unfair way to treat the basis. He then referred to Pub 575, and I told him I've read it, and if I read it as it's written, that money should be non-taxable, that nothing in there says it's as GE has it. It's done that way only so GE can keep as much of the tax benefit within the fund as possible, to the detriment of the timing of those in the fund. The whole reason I called in the first place was to tell them they had an error in my statement, and that they had switched the non-taxable portion and the taxable portion labels. Now I understand that's not the case at all. Even though another post says it's likely that this is within the regs (I'm sure it would be), I still think one could pursue an IRS letter ruling, or something similar, to establish that companies don't have the discretion to treat the basis that way. If you put the money in, after tax, and then you are drawing it out, that money can't be other money in the fund, that was put in pre-tax, but of the exact amount. That's an arbitrary switch done solely for the benefit of the plan administrator, not for the participants.


John,
If you work for GE, then I suggest, you just move on, or recharacterize it as a rollover, and pay the tax later at your convenience. I feel your pain, but sometimes we just have to fight battles we have some chance of winning, and trust me, I do not think this is one that can be won, and I have moved on, knowing that I will still get the money back, just over 20 years. The IRS is not going to issue a ruling on something that GE (with the IRS blessing) has been doing for years (IMHO.)

Use your time to focus on better use of your retirement money, by lowering future tax rates, and making better investments - that is what I am doing.

fd
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