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► Taxation Of Uncashed 401(k) Plan Distribution Checks

What happens when an individual fails to cash a distribution check from a qualified retirement plan? The Internal Revenue Service (IRS) issued guidance to answer some basic questions about the consequences.

Uncashed checks occur fairly often for plans, mostly in connection with required minimum distributions (RMDs) for participants at least 70 1/2 years old. So questions on taxation of uncashed payments by former employees have to be handled carefully by plan sponsors.

However, the new guidance, Revenue Ruling (Rev. Rul.) 2019-19, did not give direction on handling this issue when a former employee participant is “missing.”

At times, a plan administrator may redeposit an uncashed check back into the plan, but pose the question: Do we have an obligation to request the withholding back from the IRS (to deposit in the plan) and to issue an amended Form 1099-R?

Consequences Confirmed

In the new guidance, the IRS gives an example that affirms several consequences for this situation. In it, Individual A received a fully taxable distribution check from a qualified retirement plan in 2019. Individual A took no action with the distribution check (and didn’t make a rollover contribution with any part of the check).

The IRS confirmed that the amount of the distribution can be included in Individual A’s gross income in 2019, explaining that Individual A’s failure to cash the distribution check does not permit her to exclude the amount from gross income in the year of distribution. For these purposes, it doesn’t matter what actually happens to the check, the agency noted.

“This conclusion makes it clear that recipients are not allowed to manipulate the year of income inclusion by simply holding distribution checks until a later tax year,” said law firm Proskauer LLC’s client bulletin on the ruling.

The IRS also confirmed that Individual A’s failure to cash the distribution check does not alter the plan administrator’s obligation to withhold tax from the distribution under Section 3405(d)(2) of the Internal Revenue Code. Further, the plan administrator must report the distribution to Individual A on a Form 1099-R for 2019.

Because the plan administrator usually doesn’t know exactly when a participant distribution check is cashed, aligning the plan administrator’s withholding and reporting obligations to the time the check is cashed, rather than when it’s issued, “would prove very burdensome for plan administrators,” Proskauer said.

An exception to tax withholding can be made for distributions of less than $200.

Nothing More on Missing Participants

The final sentence of the IRS ruling alludes to uncashed checks and missing participants—an ongoing area of focus for the agency, as well as for the U.S. Department of Labor (DOL) (see, Make Sure You Take Sufficient Steps to Find Missing Participants).

It says the IRS is continuing to examine issues arising in some other scenarios tied to uncashed checks, “including situations involving missing individuals with benefits under those plans.” The DOL can assign a fiduciary violation against an employer that fails to distribute participant benefits when due, so plan sponsors and administrators are hungry for more specific guidance on the subject.

The tax treatment for missing participant cases seems less clear, as the plan doesn’t have a current address for a participant and may not be able to distribute a check to the individual. By comparison, the Pension Benefit Guaranty Corp. (PBGC) requires payment of the participant’s full benefit to the former employee under the agency’s missing participant program, rather than the amount minus income tax withholding.

Rev. Rul. 2019-19 also didn’t address some of the perplexing questions that can arise when distribution checks are issued close to or at year-end, and the recipient has little time to cash them in the same year.

By Jane Meacham. Ms. Meacham is the editor of BLR's retirement plan compliance publications. She has nearly 30 years' experience as a writer/editor of financial services news.



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