401(k) Corrective Distribution due to ADP Test Failure

[dkg2707]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

[toddthebod]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

You need to add the money back into your 2022 income.

[dkg2707]

Well, I reached out to both my employer HR and the plan administrator (Merrill) and both said this is a tax year 2023 event and a 1099-R will be coming to me next January. This happened to me first time but upon some search on google this seems to be a common thing for HCEs, still so much confusion surrounds in regards to which year should include the corrective distribution. There seems to be no clear consensus. Please note that, I did not overcontribute from my end (i.e. it was not my fault). My 2022 pre-tax contribution was 20,500 that shows in my last paystub and 2022 W2 as well (I am under 50). It's the employer's 401k plan that failed the ADP nondiscrimination testing for 2022 triggering the corrective distribution.

I would highly appreciate if someone with firsthand experience can comment here please on how they dealt with the tax filing.

[toddthebod]

Well, I reached out to both my employer HR and the plan administrator (Merrill) and both said this is a tax year 2023 event and a 1099-R will be coming to me next January. This happened to me first time but upon some search on google this seems to be a common thing for HCEs, still so much confusion surrounds in regards to which year should include the corrective distribution. There seems to be no clear consensus. Please note that, I did not overcontribute from my end (i.e. it was not my fault). My 2022 pre-tax contribution was 20,500 that shows in my last paystub and 2022 W2 as well (I am under 50). It's the employer's 401k plan that failed the ADP nondiscrimination testing for 2022 triggering the corrective distribution.

I would highly appreciate if someone with firsthand experience can comment here please on how they dealt with the tax filing.

Well, I hope you get someone with some real expertise to chime in, but I was just going by the 1099-R instructions:

Excess deferrals. Excess deferrals under section 402(g)
can occur in section 401(k) plans, section 403(b) plans, or
SARSEPs. If distributed by April 15 of the year following the
year of deferral, the excess is taxable to the participant in the
year of deferral (other than designated Roth contributions),
but the earnings are taxable in the year distributed. Except
for a SARSEP, if the distribution occurs after April 15, the
excess is taxable in the year of deferral and the year
distributed. The earnings are taxable in the year distributed.
For a SARSEP, excess deferrals not withdrawn by April 15
are considered regular IRA contributions subject to the IRA
contribution limits. Corrective distributions of excess
deferrals are not subject to federal income tax withholding or
social security and Medicare taxes. For losses on excess
deferrals, see Losses, later. See Regulations section
1.457-4(e) for special rules relating to excess deferrals under
governmental section 457(b) plans.

For further evidence, the regulations seem to include ADP test failures as a reason for excess deferrals.
https://www.law.cornell.edu/cfr/text/26/1.402(g)-1
Scroll down to Example 2.

[GaRPH]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

My plan fails every year apparently. It failed in 2021 and 2022. This 2022 tax return is my first time that I’ve needed to file a 1099-r for this. To the tune of $5200 unfortunately.

As far as I understand it, this will impact your 2023 return. 1. You contributed to your 401k in 2022 2. the non discrimination testing was done in 2023 and they will mail you a check in a few days still in 2023 4. They will mail you a 1099-r in 2024 and you will need to add the income to your 2023(this years income) and subsequent tax return.

Edit this is my ADP failure letter that I received on the 15th of this year:
How does this refund impact my tax reporting?
This refund is taxable income for 2023 and must be reported on your 2023 individual income tax return.
A 2023 Form 1099-R will be provided to you in January 2024, reporting the total amount refunded to
you in 2023. The refund amount is not subject to the IRS early withdrawal penalty.

[dkg2707]

For further evidence, the regulations seem to include ADP test failures as a reason for excess deferrals.
https://www.law.cornell.edu/cfr/text/26/1.402(g)-1
Scroll down to Example 2.

I keep researching on this topic and it seems there are two different things: excess deferral (contributing more than 402(g) limit which is $20,500 for 2022) and excess contribution (causing ADP test failure even if deferral is under 402(g) limit) and these two have a bit different tax treatment. Looked through a bit on https://www.law.cornell.edu and it describes the tax treatment of the corrective distribution to HCEs due to ADP test failure here: https://www.law.cornell.edu/cfr/text/26 ... )-2#b_2_vi. See the portion in bold/italics/underlined.

(vi) Tax treatment of corrective distributions -
(A) Corrective distributions for plan years beginning on or after January 1, 2008. Except as provided in this paragraph (b)(2)(vi), for plan years beginning on or after January 1, 2008, a corrective distribution of excess contributions (and allocable income) is includible in the employee's gross income for the employee's taxable year in which distributed. In addition, the corrective distribution is not subject to the early distribution tax of section 72(t). See paragraph (b)(5) of this section for additional rules relating to the employer excise tax on amounts distributed more than 2 1/2 months (6 months in the case of certain plans that include an eligible automatic contribution arrangement within the meaning of section 414(w)) after the end of the plan year. See also § 1.402(c)-2, A-4 for restrictions on rolling over distributions that are excess contributions.

Per this, it seems I should include my corrective distribution in 2023. I hope I am interpreting all these correctly.

[dkg2707]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

My plan fails every year apparently. It failed in 2021 and 2022. This 2022 tax return is my first time that I’ve needed to file a 1099-r for this. To the tune of $5200 unfortunately.

As far as I understand it, this will impact your 2023 return. 1. You contributed to your 401k in 2022 2. the non discrimination testing was done in 2023 and they will mail you a check in a few days still in 2023 4. They will mail you a 1099-r in 2024 and you will need to add the income to your 2023(this years income) and subsequent tax return.

Edit this is my ADP failure letter that I received on the 15th of this year:
How does this refund impact my tax reporting?
This refund is taxable income for 2023 and must be reported on your 2023 individual income tax return.
A 2023 Form 1099-R will be provided to you in January 2024, reporting the total amount refunded to
you in 2023. The refund amount is not subject to the IRS early withdrawal penalty.

Thanks for sharing your experience. This seems to be in line with what I am reading so far on the internet that I posted above.

[worthit]

OP, this happened to me few years ago and I received a communicaton from from the HR/administrator starting that I need to report the income on my tax return and that is what I did if I recall. Nothing too complicated. So you may want to check with your HR/administrator.

[Alan S.]

When the 1099R for 2023 is entered into a tax program, the taxable income should show up on line 1h of Form 1040. Prior to 2022 it was added to line 1 wages, but Form 1040 now breaks out the wage income into several components that get different treatment.

These amounts should never show on lines 5a and 5b (plan distributions) of your 1040. If they do either the 1099R or the entry of the 1099R data is incorrect.

[Hyperchicken]

First hand experience here. It's really simple.

1) Check box 7 - distribution code, then look at the back side for instructions. You should see something like:

8—Excess contributions plus earnings/excess deferrals (and/or earnings) taxable in 2022.

Note: this will be the year the 1099 is for. If you receive a 2023 1099-R, it will be taxable in 2023.
Based on the dates in the OP, it should be a 2023 1099-R.

2) Distribution amount - goes on form 1040 line 1h (used to be line 1 in prior years) - from the instructions (keyword: corrective):

Corrective distributions from a retirement plan shown on Form 1099-R of excess elective deferrals and excess contributions (plus earnings).

3) Federal income tax withheld - goes on form 1040 line 25b.
4) State income tax withheld.

***

In my experience, income tax is withheld from corrective distributions at low rates:

Federal - 10%
State (CA) - 1%

So if you are in a higher bracket, that will shift the balance toward owing more.

The timing of HR communication points to this being taxable in 2023.

[stocknoob4111]

I had this happen in the past with an employer and it was considered income in the year it was distributed so nothing to do with the past. It is a huge disappointment to go through this and i've been there. Thankfully that was the only employer that I had this happen, all future employers had safe harbor plans.

[marcopolo]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

My plan fails every year apparently. It failed in 2021 and 2022. This 2022 tax return is my first time that I’ve needed to file a 1099-r for this. To the tune of $5200 unfortunately.

As far as I understand it, this will impact your 2023 return. 1. You contributed to your 401k in 2022 2. the non discrimination testing was done in 2023 and they will mail you a check in a few days still in 2023 4. They will mail you a 1099-r in 2024 and you will need to add the income to your 2023(this years income) and subsequent tax return.

Edit this is my ADP failure letter that I received on the 15th of this year:
How does this refund impact my tax reporting?
This refund is taxable income for 2023 and must be reported on your 2023 individual income tax return.
A 2023 Form 1099-R will be provided to you in January 2024, reporting the total amount refunded to
you in 2023. The refund amount is not subject to the IRS early withdrawal penalty.

Thanks for sharing your experience. This seems to be in line with what I am reading so far on the internet that I posted above.

Either there is some flexibility in how companies/plans choose to handle this, or the regulations changed a few years ago.

I had to deal with this for a number of years. For the early years we got a notice telling us to hold off doing our taxes for the previous year because we failed the test a d would be getting a distribution. The distribution usually came around late March, and then I had to rush to get my taxes filed. Then, at some point we stopped getting the warning letter to hold off doing our taxes, we simply got the distribution and were told it would be reportable in the coming year tax return.

As I said, I am not sure if plans have flexibility around how to report the distribution, or if the regulations around how they are handled changed. If the former, then you might need to ask your plan administrator what they plan to do. If the later, them nothing to do at this time.

as an aside, I was always amazed our plan failed the test almost every year. My employer provided 100% match up to 10% of income, and there were still enough people that did not contribute that the plan failed the test most years!

[marcopolo]

I got notified by my employer HR on Mar 15th that they failed ADP (actual deferral percentage) test for 2022 and I am getting a what they are calling "Corrective Distribution".

Does this impact my 2022 tax return? I almost finished my 2022 tax preparation and was planning to file it this weekend; now I am holding it off . Which tax year should include this corrective distribution?

My plan fails every year apparently. It failed in 2021 and 2022. This 2022 tax return is my first time that I’ve needed to file a 1099-r for this. To the tune of $5200 unfortunately.

As far as I understand it, this will impact your 2023 return. 1. You contributed to your 401k in 2022 2. the non discrimination testing was done in 2023 and they will mail you a check in a few days still in 2023 4. They will mail you a 1099-r in 2024 and you will need to add the income to your 2023(this years income) and subsequent tax return.

Edit this is my ADP failure letter that I received on the 15th of this year:
How does this refund impact my tax reporting?
This refund is taxable income for 2023 and must be reported on your 2023 individual income tax return.
A 2023 Form 1099-R will be provided to you in January 2024, reporting the total amount refunded to
you in 2023. The refund amount is not subject to the IRS early withdrawal penalty.

Thanks for sharing your experience. This seems to be in line with what I am reading so far on the internet that I posted above.

Either there is some flexibility in how companies/plans choose to handle this, or the regulations changed a few years ago.

I had to deal with this for a number of years. For the early years we got a notice telling us to hold off doing our taxes for the previous year because we failed the test a d would be getting a distribution. The distribution usually came around late March, and then I had to rush to get my taxes filed. Then, at some point we stopped getting the warning letter to hold off doing our taxes, we simply got the distribution and were told it would be reportable in the coming year tax return.

As I said, I am not sure if plans have flexibility around how to report the distribution, or if the regulations around how they are handled changed. If the former, then you might need to ask your plan administrator what they plan to do. If the later, them nothing to do at this time.

as an aside, I was always amazed our plan failed the test almost every year. My employer provided 100% match up to 10% of income, and there were still enough people that did not contribute that the plan failed the test most years!

[bartl007]

Had this happen every year for the last 5 years with my employer. You will owe income tax for the year the excess funds are distributed back to you (2023 tax year). So you can go ahead and file your 2022 return and not worry about this now.

You should receive the check in the mail in 1-2wks. Make sure both HR AND your account custodian has the correct address on file (first time this happened they sent my $4k check to an old address!)

You'll receive the 1099-R for 2023 taxes at some point later on, but probably good to keep the check stub with your records so you don't forget about it when putting everything together for next year's tax return.

[dkg2707]

Got the corrective distribution check in mail today. It is just (thankfully) for two hundred something dollars and they withheld exactly 15% tax (calculated from the difference of the amount that HR told me and the amount on the check).

I hope nothing else to do this year now in this regard other than depositing the check into one of my checking accounts and waiting for a 1099-R next year January.

[kd2008]

OP, 2023 tax return is in filed in 2024. That when you will include your 1099-R that you will receive in Jan 2024.

It doesn't impact 2022 tax return filed by April 17th this year.