401K distribution deferred in 2020 and tax deduction used

[Francine]

In 2020 my client took a 3 year deferral on a 401k distribution for 3 years. Should the taxes he paid in 2020 have also be deferred? They were not and now client owes taxes on the amount included in 2021 return.  How do I handle this?

[Just-Lisa-Now-]

No, all the withholding was used in the first year. 

This was a big portion of the conversation I had with clients when they decided to do the 3 year income spread.  They needed to realize that the 2021 and 2022 portions of income would have NO withholdings and they needed to be prepared for that tax hit.

[qbteachmt]

Let's see if restating this will help:

"took a 3 year deferral"

Did not opt out of reporting the taxable income over three years. It's not a Deferral. It's allowed to be spread over three years or fully reported in the year of distribution.

"on a 401k distribution for 3 years. Should the taxes he paid in 2020 have also be deferred?"

The taxes are just taxes. Taxes for this are neither deferred or spread out. Each year's tax form has the amount owed, and any withholding is what has been prepaid, along with any estimated payments made.

It's different for the SE Tax. For the SE tax, it was all reported in the year owed, and the Payment Option was to put the deferred Tax on a Payment schedule of 1/2 by Dec 31, 2021 and 1/2 by Dec 31, 2022.

We've seen people confuse these provisions.

[Francine]

Thank You!  This is what I told my client and he insists that he has already paid taxes on the amount included on the 2021 return. I also told him that he was a cash basis taxpayer and that taxes are deducted in the year PAID!   Also, that taxes paid are not deferred. Taxes are taxes as stated in my second reply.

[qbteachmt · Accepted solution]

"This is what I told my client and he insists that he has already paid taxes on the amount included on the 2021 return."

Show him how much was the distribution, and how much was reported for taxes on 2020. That will help you confirm you did not report all of it for that year, as well.

"I also told him that he was a cash basis taxpayer and that taxes are deducted in the year PAID!"

Nothing about this is deductible.

"Also, that taxes paid are not deferred. Taxes are taxes as stated in my second reply."

Here's a common confusion in the way we use Tax Language:

People confuse Withholding and Estimates, which are Prepayments against Likely taxes, and Taxes. The end result of preparing the tax form is Balance Due or Refund Due, based on Taxes Owed offset by those prepayments.

You see this all the time with people cheering for their Refund "of taxes" and it's simply their own money, overpaid to the IRS.

[Francine]

My client still insists that he has already paid taxes on the distribution. He insists that I need to go back and amend the 2020 return taxes paid on the distribution and distribute the taxes paid on the distribution and the distribution over 3 years! He says that the IRS website agrees with his understanding as to how this should be done.  My way he says that he is paying taxes on the distribution twice! He has talked to several CPA's and they agree with him.

What can I do to convince him that taxes paid in a year are deducted in that year?

[Just-Lisa-Now-]

Have him show you where hes reading on the IRS website that agrees with him.

Hes not paying taxes on them twice, he had withholding on the total but all the withholding was used up in year one.

IF you amended 2020 to spread out the withholding (which you can't, that's no how it works), then he'd owe back that withholding that was claimed in 2020, so his plan doesn't help him.

[Francine]

https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-....

This is what he is referring to on the site. Could not get him to see what that means!

Thank You for helping.

[Just-Lisa-Now-]

Thats correct, the distribution gets spread over 3 years, that paragraph doesn't mention anything about withholding.

I don't argue with clients over things like this. If he doesn't want to use my services, hes more than welcome to find a different preparer.

[qbteachmt]

Read him his own 2020 tax form against his own 1099-R, and show him the taxes and the taxable amount there. I always offer them the benefit of the doubt, "Let's work through it together." Of course, you would have already reviewed, flagged and/or highlighted what you will show him, so it goes quickly, and that is your chance to confirm you made no errors.