T5008 Canada ESOP cash distribution

[Tributos]

When they left their employer, TP reported a full cash distribution of their ESOP as a Cap Gain on a Sch D/8949. No 1099R or 1099B was received by the Plan Admin. 

Two years later, TP receives a 4669 Statement of Payments Rec'd from the Plan Admin asking TP to acknowledge that taxes were not withheld. If TP agrees to the amount subject to withholding the Plan Admin won't require payment for those taxes.

If the 4669 is not signed by April 2024, then the Plan Admin says they require payment for those withholding taxes instead.

First, this was a full cash distribution when the TP left the company. All stock was 'converted' to cash and not rolled over into any other plan.

What are next steps if they do not provide TP a 1099 to correct his previous tax return?

[itonewbie]

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@Tributos wrote:

Two years later, TP receives a 4669 Statement of Payments Rec'd from the Plan Admin asking TP to acknowledge that taxes were not withheld. If TP agrees to the amount subject to withholding the Plan Admin won't require payment for those taxes.

If the 4669 is not signed by April 2024, then the Plan Admin says they require payment for those withholding taxes instead.

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The employer's and your understanding of F.4669 is not correct.  The employee will not be paying over any underwithholding to the former employer at this point, whether or not the employee agrees to provide the statement.  (As a side note, the employer is on the hook for taxes owed.)

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First, this was a full cash distribution when the TP left the company. All stock was 'converted' to cash and not rolled over into any other plan.

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Are you sure the stocks were "converted"?  At your client's request or defaulted by the former employer?  Take a look at §409(h) paragraphs (2)(B) and (3) for when distributions may be made in cash.  Since you mentioned T5008, the presumption is that the former employer's stocks are readily tradable on an established market.

Given the distribution was made in cash, it should have been taxable at marginal rates, which means your client has likely underpaid.  Thinking out loud... what basis did your client report for the "underlying" shares?

You also did not mention the age of your client at the time of termination.  It is likely your client would have been subject to the 10% early distribution penalty.

Lastly, failure of the employer or trustee to issue the necessary 1099's, etc., does not negate your client's responsibility to report his/her taxes correctly.

[Tributos]

Form 4669 - I did see on the back of the form that the payor is liable for withholding. Their additional notes I mentioned didn't seem correct, plus they are listing the w/h for 2023 and the transaction happened in 2021. (he signed the doc before our engagement). 

I am not certain if the stocks were available on the market but can see if I can locate a CUSIP#. I am not that familiar with ESOP's - but am with brokerage statements.

What caused the distribution was termination from the company. The employee used the last three years to determine their basis and recognized all as short term on SchD, yet way under reported. They will encounter the 10% penalty.

Thanks so much for your response & I will review the section you reference. To course correct, I will have the client determine their basis, which will have to be between them and the Plan Admin. Part of the basis is from the client and part from the employer. 

I suppose it should still be reported on a Sch. D, to list basis and not a net amount on a 1099-R? Initially, I felt it should be on a 1099-R because all company stock was relinquished, and nothing rolled to another plan. 

[itonewbie]

The point about the employer being responsible for underwithholding is only a technical point.  See §31.3403-1.  The IRS will first try to recover the shortfall from the individual taxpayer.

The stock doesn't have to be traded on the US markets.  Canadian markets are recognized for tax purposes as well.

You may like to read up on ESOP, which is not the same as ESPP and is governed by different code sections.  Don't see how there would be any "basis" and am not convinced, given the limited info you provided, that the distribution should be reported on Sch D.

[Tributos · Accepted solution]

I appreciate the very helpful tax code citations to support the course I will recommend to the client. When first looking into the situation I came across a resource ESOP Distribution & Taxation: How Does it Work? What Are the Rules? (esoppartners.com) where I first gathered this distribution should be reported on a 1099-R:

“If an ESOP pays dividends directly to participants, those dividends are not subject to the excise tax of early distributions. They are also exempt from income tax withholding — but dividend payments are fully taxable.

In the case when an ESOP distributes actual shares of company stock, rather than paying out the value of the shares in cash, the employee pays income tax at ordinary tax rates on the value of company contributions to the plan, plus capital gains tax on appreciation in share value when they choose to sell their shares.

Whenever participants receive ESOP distributions of $10 or more, the ESOP trustee or third-party administrator (TPA) is required to prepare and submit Forms 1099-R and 945 for ESOP taxation reporting.”

What it comes down to then, is the Plan Admin apparently missed the withholding, which they are accountable for any fallout from that, and the taxpayer is ultimately responsible for the tax due on the whole distribution (and the early w/d penalty).

Seems so simple in the last paragraph 😊 still glad I’ve done my due diligence.

Thanks again for your help!