By Pension and Benefits Editorial Staff
The IRS has clarified that income tax withholding requirements and Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.) reporting will apply to a qualified retirement plan administrator’s payment of an individual’s accrued benefit to a state’s unclaimed property fund, under certain circumstances.
The IRS notes that this guidance covers qualified retirement plans under Code Sec. 401(a) that do not include designated Roth accounts under Code Sec. 402A, hold employer securities, or provide benefits described in Code Sec. 104 (compensation for injuries or sickness) or Code Sec. 105 (amounts received under accident and health plans).
Under the fact situation provided by the IRS, an individual has an accrued benefit in a qualified retirement plan with a value of $900, has not made a withholding election under Code Sec. 3405 with respect to her benefit, and has no investment in the contract within the meaning of Code Sec. 72 with respect to her benefit. In 2020, the individual’s accrued benefit (net of any applicable withholding) is paid to a state’s unclaimed property fund, under which a claim for property may be made by an owner.
Withholding rules. Under Code Sec. 3405(d), the payor or plan administrator must withhold from a designated distribution, and be liable for, payment of the tax required to be withheld under Code Sec. 3405. Under Code Sec. 3405(e)(1)(A), the term “designated distribution” generally means any distribution or payment from or under an employer deferred compensation plan, which includes any pension, annuity, profit-sharing, or stock bonus plan, or other plan deferring the receipt of compensation. Thus, an employer deferred compensation plan includes a qualified retirement plan under Code Sec. 401(a).
The IRS notes that there are exceptions to treating amounts as designated distributions, but the exceptions do not apply to the presented facts. In addition, the IRS observes that Code Sec. 3405(e)(1)(B)(ii) provides that a designated distribution does not include the portion of a distribution or payment it is reasonable to believe is not includible in gross income. However, the IRS explains that, under the facts presented, it is not reasonable for the employer to believe that the payment of any portion of the individual’s accrued benefit from the plan is not includible in gross income. Thus, the payment, including the amount withheld, is a designated distribution and is subject to federal income tax withholding under Code Sec. 3405(d).
Reporting requirements. An employer maintaining a plan from which designated distributions (as defined in Code Sec. 3405(e)(1)) may be made, or the plan administrator of that plan, is required to make returns and reports regarding the plan. However, no return or report is required with respect to distributions to any person during any year unless the distributions are $10 or more.
The IRS notes that the plan’s payment of the individual’s accrued benefit, including both the amount sent to the state unclaimed property fund and the amount withheld, is a designated distribution that exceeds the reporting threshold. Accordingly, the employer is required to report that designated distribution in Box 1, and the federal income tax withheld in Box 4, of the Form 1099-R for 2020.
Transition relief. The IRS provides that a person will not be treated as failing to comply with the withholding and reporting requirements described above for payments made before the earlier of January 1, 2022, or the date it becomes reasonably practicable for the person to comply with those requirements.
Source: IRS Rev. Rul. 2020-24
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