It has been three years since the IRS issued its version of the “402(f)” notice that retirement plans must provide before paying a distribution that is eligible for rollover to an IRA. (IRS Notice 2009-68.) Buried in the IRS notice is a description of rollover rules for after-tax money that does not follow Internal Revenue Code section 402(c)(2). The IRS should correct this notice, as it presents unjustified complications for individuals who wish to make a direct IRA rollover of taxable retirement plan money and also receive a distribution of after-tax retirement plan money.
Detailed analysis of this error in the IRS notice appears in correspondence to the IRS from interested parties such as the American Benefits Council. See http://www.americanbenefitscouncil.org/documents/followup_letter_re_402c2.pdf
The IRS position is particularly illogical because it can be avoided through an indirect rollover. According to the IRS position, a portion of a plan’s after-tax distribution is taxable when paid to a recipient who also makes a direct rollover of a taxable distribution from the plan to an IRA. However, the IRS concedes that the after-tax distribution is not taxable if the recipient takes the extra step of first receiving the entire distribution (including after-tax and pre-tax money and paying 20% withholding tax) and then rolling the taxable money to an IRA within 60 days. It is illogical for the IRS to adopt a policy that gives an indirect rollover more favorable tax treatment than a direct rollover. It is also contrary to the plain wording of Internal Revenue Code section 402(c)(2). The IRS owes the pension community a long overdue correction of this error. A three year delay in taking corrective action is too long, particularly for retirement plan sponsors who struggle to satisfy the many complex deadlines the IRS applies to their tax law compliance.
marybrauerlaw 