Employer Must Withhold and Report Plan Payments to Unclaimed Property Funds

(Parker Tax Publishing October 2020)

The IRS ruled that an individual's accrued benefit from a qualified retirement plan that was paid to a state unclaimed property fund was subject to withholding under Code Sec. 3405(d) because it was a designated distribution under Code Sec. 3405(e)(1)(A) and none of the exceptions under Code Sec. 3405(e)(1)(B) applied. The IRS further ruled that the payment of the accrued benefit, including both the amount sent to the state unclaimed property fund and the amount withheld, was subject to the reporting requirement under Code Sec. 6047(d). Rev. Rul. 2020-24.

Background

The IRS was asked to rule on a situation involving the payment from a qualified retirement plan to a state unclaimed property fund. Under the facts in the ruling, an employer is the plan administrator of a qualified retirement plan under Code Sec. 401(a) that does not (1) include designated Roth accounts under Code Sec. 402A, (2) hold employer securities, or (3) provide benefits described in Code Sec. 104 (compensation for injuries or sickness) or Code Sec. 105 (amounts received under accident and health plans). An individual who is a U.S. person with a calendar year tax year had an accrued benefit in the plan with a value of $900. That individual did not make a withholding election under Code Sec. 3405 with respect to her benefit, and had no investment in the contract under Code Sec. 72 with respect to her benefit. In 2020, the individual's accrued benefit (net of any applicable withholding) was paid to a state unclaimed property fund, a fund under which a claim for property may be made by an owner.

Code Sec. 3405 provides federal income tax withholding rules with respect to designated distributions. Under Code Sec. 3405(d), the payor or plan administrator must withhold from a designated distribution, and is liable for, payment of the tax required to be withheld under Code Sec. 3405. Under Code Sec. 3405(e)(1)(A), the term "designated distribution" means, except as provided in Code Sec. 3405(e)(1)(B), any distribution or payment from or under an employer deferred compensation plan, an individual retirement plan, or a commercial annuity. Under Code Sec. 3405(e)(5), the term "employer deferred compensation plan" includes any pension, annuity, profit-sharing, or stock bonus plan, or other plan deferring the receipt of compensation. A qualified retirement plan under Code Sec. 401(a) is an employer deferred compensation plan.

Code Sec. 3405(e)(1)(B)(i), (iii), and (iv) provides exceptions to treatment as a designated distribution with respect to amounts that are wages, amounts that are subject to withholding on nonresident aliens and foreign corporations, and distributions described in Code Sec. 404(k)(2) relating to dividends on employer securities. In addition, Code Sec. 3405(e)(1)(B)(ii) provides that a designated distribution does not include the portion of a distribution or payment it is reasonable to believe is not includible in gross income.

Under Code Sec. 6047(d), an employer or plan administrator must report designated distributions of $10 or more on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. The 2020 instructions to Form 1099-R provide that the total amount of the distribution (before income tax or other withholding) must be reported in Box 1 and the federal income tax withheld must be reported in Box 4 of the Form 1099-R.

Analysis

In Rev. Rul. 2020-24, the IRS addressed whether, under the above facts, the payment of the individual's accrued benefit from the plan was subject to withholding under Code Sec. 3405 and to reporting under Code Sec. 6047. The IRS ruled that the payment was subject both of these requirements.

The IRS determined that none of the exceptions in Code Sec. 3405(e)(1)(B) applied and, thus, the payment of the individual's accrued benefit, including the amount withheld, was a designated distribution under Code Sec. 3405(d). The IRS further found that, under the facts presented, it was not reasonable for the employer to believe that the payment of any portion of the individual's accrued benefit from the plan was not includible in the individual's gross income. Thus, the IRS concluded that the plan's payment of the individual's accrued benefit, including both the amount sent to the state unclaimed property fund and the amount withheld, was a designated distribution under Code Sec. 3405(e)(1) that exceeded the reporting threshold. Accordingly, the IRS ruled that the employer was required to report that designated distribution in Box 1, and the federal income tax withheld in Box 4, of the Form 1099-R for 2020 issued to the individual.

Rev. Proc. 2020-24 provides transition relief under which a person will not be treated as failing to comply with the withholding and reporting requirements described Rev. Rul. 2020-24 with respect to payments made before the earlier of January 1, 2022, or the date it becomes reasonably practicable for the person to comply with these requirements.

For a discussion of the withholding rules for designated distributions, see Parker Tax ¶212,150. For a discussion of the requirement to report designated distributions on a Form 1099-R, see Parker Tax ¶133,135.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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