IRS Rules on Tax Treatment of Uncashed Distribution Checks

The IRS has published a new Revenue Ruling outlining its position on the tax treatment of uncashed retirement plan distribution checks.

In addition to answering the question of whether an individual’s failure to cash a distribution check she received in 2019 permits her to exclude the amount of the designated distribution from her gross income in that year, the Revenue Ruling also addresses the employer’s obligations in this situation.

In particular, the Revenue Ruling addresses whether an individual’s failure to cash a distribution check received alters the employer’s obligations with respect to withholdings under Revenue Code Section 3405. Additionally, it clarifies whether the individual’s failure to cash the distribution check received alter the employer’s obligations with respect to reporting under Code Section 6047(d).

The Situation

Before addressing these matters, the Revenue Ruling first explains the exact situation IRS compliance staff is considering here.

The ruling is considering a qualified retirement plan under Revenue Code Section 401(a) that does not include a qualified Roth contribution program under Section 402A(b). An individual in this plan, the IRS explains, must make a distribution of $900 in 2019. In this situation, the individual has “no investment in the contract within the meaning of Code Section 72” with respect to her benefit, has a calendar year taxable year, and has never made a withholding election with respect to her benefit.

In the model example, the employer makes the required $900 distribution, technically a designated distribution within the meaning of Section 3405(e)(1), by withholding tax as required under Section 3405(d)(2) and mailing a check for the remainder to individual. Although the individual receives the check and could cash it in 2019, she does not do so. Also important to this situation, the individual does not make a rollover contribution with respect to any portion of the designated distribution, and no other exception to income inclusion under Section 402(a) applies.

The IRS Position on ‘Distributee’ Taxes

In a phrase, the IRS’s position is that this situation does not permit the individual to exclude the distribution from gross income in 2019.

The rationale for this position is that Code Section 402(a) provides that, except as otherwise specifically provided in the Section, any amount “actually distributed to an distributee by an employees’ trust described in Section 401(a) which is exempt from tax under Section 501(a) is taxable to the distributee, in the taxable year of the distributee in which distributed, under Section 72.”

Section 72, in turn, provides rules relating to inclusion in gross income of amounts received from qualified plans and certain other arrangements.

“[The individual’s] failure to cash the distribution check she received in 2019 does not permit her to exclude the amount of the designated distribution from her gross income in that year under Section 402(a),” the Revenue Ruling states.

Implications for Employers and Trusts

In this situation, the employer, as the plan administrator, rightly withheld tax as required under Section 3405(d)(2) from the individual’s designated distribution. According to the Revenue Ruling, the individual failure to cash the distribution check received does not alter the employer’s obligations with respect to withholding of tax, or liability for payment of that tax, under Section 3405.

The Revenue Ruling notes that, under the 2019 instructions to Form 1099-R, a Form 1099-R must be filed for each person to whom a designated distribution of $10 or more has been made, and the total amount of the distribution (before income tax or other withholding) must be reported. In addition, under those instructions, the taxable amount of the distribution (including income tax withheld) must be reported, and the federal income tax withheld must be reported.

In this model example, the plan distribution, including both the amount of the check and the amount withheld, is a designated distribution under Section 3405(e)(1) that exceeds the reporting threshold. Accordingly, the employer is required to report that designated distribution in Box 1 of a Form 1099-R for 2019.

“Because Individual A has no investment in the contract within the meaning of Section 72 and no exception to income inclusion under Section 402(a) applies, Employer M must report the same amount in Box 2a as in Box 1 and must report the federal income tax withheld in Box 4,” the Revenue Ruling stipulates. “Individual A’s failure to cash the distribution check she received does not alter Employer M’s obligations with respect to reporting under Section 6047(d).”