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George F. Bearup, J.D. Senior Legal Trust Advisor

19-Aug-19

Taxable Income Even When the Check is Not Cashed

Take-Away: The IRS confirms that the failure to cash a distribution check from a qualified plan is still included in the participant’s taxable income for the year, including automatic withholding of income taxes.

Background: The Tax Code provides that any amount actually distributed to a distributee by an employees’ trust [IRC 401a], which trust is exempt from income taxation [IRC 501(a)], which means a qualified retirement plan, is taxable to the distributee in the taxable year of the distribution. [IRC 72.]

Revenue Ruling: 2019-19

Facts: The taxpayer [‘A’] was a participant in a qualified retirement plan. That plan did NOT have a Roth contribution program. The plan administrator was required [it is not clear why the distribution was required ]to make a $900 distribution to the participant in 2019. The plan administrator withheld taxes from the distribution, and it distributed the ‘net’ amount to A in the form of a check. A, the participant, is mailed the distribution check and could cash it in 2019, but she does not do so. A does not make a rollover contribution with respect to any portion of the designated distribution.

In a footnote the IRS concluded: “For purposes of this revenue ruling, whether individual A keeps the check, sends it back, destroys it, or cashes it in a subsequent year is irrelevant.” Thus, letting the distribution check sit in a desk drawer will not avoid having to pay the income tax.

Because A had no investment [i.e. after-tax contributions] in the qualified plan account and no statutory exception to the taxation of that distribution applied [IRC 402(a)], the amount distributed  to the participant was automatically includible in A’s gross income in 2019.

IRS Holdings:

  • Distribution Taxable: A’s failure to cash the distribution check that was mailed to her in 2019 does not permit her to exclude the amount of the distribution from her gross income in 2019. [IRC 402(a).]
  • Withholding: The plan administrator is required to withhold, and is liable for payment of the income tax that is required to be withheld from the distribution. [IRC 3405(d)(2)).] The exception to this rule, which makes the plan administrator liable for the income tax on the distribution, is if the plan administrator directs the payor [i.e. the plan trustee that writes the check] to withhold the income tax and the plan administrator provides the payor-trustee with such information as required under the Regulations. A’s failure to cash the distribution check mailed to her does not alter the plan administrator’s obligations with respect to withholding the income tax liability on the distribution, and its statutory liability for payment of that income tax. [IRC 3405.]
  • Reporting: The employer that maintains the qualified plan from which designated distributions may be made, or the plan administrator of the plan, must file returns and reports with regard to the qualified plan and distributions from it. [IRC 6047(d).] No such return or report is required however with regard to distributions to any person during any year unless the distributions aggregate $10.00 or more. [IRC 3405(e)(1).] Form 1099-R is used to satisfy this reporting obligation. The taxable amount is reported on this form, and the federal income tax withheld is also identified on the Form 1099-R.  In this case, the $10 threshold amount was exceeded; therefore, the employer-plan administrator was required to file the Form 1099-R, even though A did not cash the distribution check.

Conclusion: This is a strange IRS Revenue Ruling, in part due to its reference to a distribution in 2019 and also the relatively amount distributed, $900. Perhaps the reason for a Revenue Ruling is the last sentence of the Revenue Ruling: “ The Department of Treasury and the Internal Revenue Service continue to analyze issues that arise in other situations involving uncashed checks from eligible retirement plans described in Section 402(c)(8)(B), including situations involving missing individuals with benefits under those plans.” Perhaps A is missing and thus the question arose if the plan administrator had to follow through with tax withholding and filing Form  1099-R. The key message is that in the absence of a rollover to an IRA, distributions from a qualified plan will be subject to tax withholding.