401m Plan - Post Tax Employee Contributions

[GodFather]

Through their employer, client was part of a 401m plan that offered employee contributions post-tax and employer match pre-tax. Upon retirement, client had had the balance of the account transferred to his personal Vanguard account. When that transfer occurred, the funds were somehow comingled. Years have gone by and the client notices the issue and contacts Vanguard seeking a remedy. Vanguard offers to transfer the post-tax balance into a Roth. In doing so they issued a 1099-R, and I'll use round numbers:

The 1099-R was for $100,000 which included $25,000 reflecting his normal yearly distribution, and $75,000 as the post-tax amount being transferred into a Roth. Box 1 and Box 3 reflected $100,000. It was coded as a 7 and obviously the entire distribution was processed as taxable, including the $75,000 that was already taxed.

Client spoke with Vanguard who said they will provide a letter of explanation that can be used to justify not including the $75,000 as part of the taxable amount.  I'm not aware of any way to deal with this on the 8606 and feel Vanguard  should issue a corrected 1099-R.  I can attach the letter to the efile but have little faith (even on Good Friday) it will be looked at. 

Is there a way not to have the $75,000 not included as a taxable distribution that maybe I am unaware of ?  Wait and deal with any IRS notifications?  Would appreciate any thoughts.

[qbteachmt]

I'm going to ask for some clarification:

"to his personal Vanguard account."

Which type of account is that? Roth IRA? Brokerage? Trad IRA? Commingled into what?

"Vanguard offers to transfer the post-tax balance into a Roth."

Only the amount that was from employee elective deferrals, then? Not including any earnings?

"for $100,000 which included $25,000 reflecting his normal yearly distribution"

The 1099-R broke it out into two parts?

The 1099-R is for money Out. There is no correction issued just because of whatever happened to the money afterwards. It's a normal distribution, and then any number of things are done with the funds, after being released.

"the $75,000 not included as a taxable distribution"

That code 7 is not the final status. It's the initial status, such as "no know exception applies" doesn't mean there is no exception. It just isn't known to the 1099-R issuer.

I don't think 401(m) has a Designated Roth provision, otherwise code B (or H) might apply with that amount.

Pending the answers from above: "Years have gone by"

So, basis alone won't resolve your entries. It seems you are going to have a variety of Basis (since Vanguard is using an older account balance for the Roth part) to be nontaxable, taxable earnings from all of the contributions/match (pre-tax and post-tax) and some sort of nontaxable rollover. And typically, that basis would be considered for a pro-rata taxable rollover. I don't know if there is some specific condition that allows this Roth amount to be selective (not pro rated).

You either have some research to do or need a benefits manager to help with this.

[GodFather]

Thank you for your reply. 

I'm going to ask for some clarification:

"to his personal Vanguard account."

Which type of account is that? Roth IRA? Brokerage? Trad IRA? Commingled into what?  Brokerage.     

"Vanguard offers to transfer the post-tax balance into a Roth."  Just the post-tax. 

Only the amount that was from employee elective deferrals, then? Not including any earnings?  No earnings.  I guess they could not determine that for whatever reason.  

"for $100,000 which included $25,000 reflecting his normal yearly distribution"

The 1099-R broke it out into two parts?  1099 only showed $100,000 in total.  He normally withdraws the $25,000. 

The 1099-R is for money Out. There is no correction issued just because of whatever happened to the money afterwards. It's a normal distribution, and then any number of things are done with the funds, after being released.  Thank you. 

"the $75,000 not included as a taxable distribution"  $75,000 was included as a taxable distribution.  

That code 7 is not the final status. It's the initial status, such as "no know exception applies" doesn't mean there is no exception. It just isn't known to the 1099-R issuer.

I don't think 401(m) has a Designated Roth provision, otherwise code B (or H) might apply with that amount.  It does not have a Roth provision. 

Pending the answers from above: "Years have gone by"  3 years. 

So, basis alone won't resolve your entries. It seems you are going to have a variety of Basis (since Vanguard is using an older account balance for the Roth part) to be nontaxable, taxable earnings from all of the contributions/match (pre-tax and post-tax) and some sort of nontaxable rollover. And typically, that basis would be considered for a pro-rata taxable rollover. I don't know if there is some specific condition that allows this Roth amount to be selective (not pro rated).

You either have some research to do or need a benefits manager to help with this.

[qbteachmt · Accepted solution]

"client had had the balance of the account transferred to his personal Vanguard account."

If all of this went to a Brokerage account, that is a full conversion to normal funds, the same as if this was put in savings. It no longer is retirement or deferred or even qualified for rollover. This would have been pro rata taxabled at the time it converted. That also would explain the commingling. Have you looked at the tax return from that year and the 1099-R? The only part that would not be taxable is anything that was contributed post-tax (basis).

All of the rest is moot, now that we know it came out of a sheltered status.

And this part makes no sense: I asked if the 1099-R broke it out into two parts?  Answer: 1099 only showed $100,000 in total.  He normally withdraws the $25,000. 

But a 1099-R is not issued for amounts out of a Brokerage account. Also, you cannot arbitrarily or with any responsibility assign what is or is not the split of the 1099-R. The split is what occurs afterwards. That's why there is no corrected 1099-R expected, even if this makes sense from 3-years ago.

The $100,000 reflects the amount removed. Period.

I don't understand how some brokerage account amount can be treated as a rollover, three years later. I don't know about corrective actions for some action taken three years prior to the action taken now, when the brokerage made the mistake. Vanguard's letter doesn't control how the IRS would even require this to be treated. I'm pretty informed on this stuff, and have even had Schwab admit to errors in handling accounts (and tons of Payroll providers, too). This one is going to require some research, as I noted, but first, you might find it's all water under the bridge.

[GodFather]

Thank you for the information.