Wife surprised me, she is now a highly compensated employee

[bssc]

My wife has been working overtime a lot the last couple of month. We had maxed out last year on our 401(k) contributions. When I went to add the additional 500 increase for this year (to 15,500), the system would not let me because she is now considered a highly compensated employee in 2006. There is not a lot we can do about it since she works for a Dow Component company with 300,000+ people.

I searched but didn't find anything specific to my question (but that doesn't mean it was there and I missed it). My questions are:

1) Since this took place in 2006 and we maxed out, what are the rules behind this? I am sure that we will hear from HR but they have messed her up before. If they return part of the contributions (probably $5000+), will I need to report this on our taxes in 2006 or 2007? If it was 2006 and we don't hear from HR, we will need to bug them.

2) How often do they calculate the threshold?

Needless to say, there are a lot more worse issues to have but I am lazy and don't want to have to submit a 1040X if I don't have to.

 

[KM]

I believe you will see a refund at some point. My husband was in a similar situation this year in that we have to contribute to his 401k by %. So I estimated the % based on last year's income. He had more overtime this year, so he went over the threshhold. Now the interesting thing is they caught it on the first contribution after he was over the max, but not the contribution that met and exceeded the max. We were told to expect a refund in April of the excess. I am assuming we will claim in as income in 2007. In our case, it will obviously be a much smaller amount, as it was only a partial contribution for one week.

I am not an expert, so take this for what it's worth. But in the meantime, I would have her contact her payroll department and ask them when she can expect the refund. In our case, it wasn't the payroll department that notified us. It was his 401k plan administrator, when we called them with a totally unrelated question.

Good Luck!

 

[magellan_nh]

[Vent mode on]

I've got to comment that the rules for "highly compensated" wrt 401ks are some of the dumbest ever created by congress. I understand the intent, but to try to solve what's essentially a macro problem at the micro level is absolutely ridiculous, and like lots of other parts of the tax code leads to unexpected consequences.

Case in point...

In the 90s, I was an engineer at a tech company that did all their own manufacturing in the good 'ol USA. Because the hourly manufacturing folks were numerous and were paid relatively low wages compared to engineers, I was considered highly compensated and my 401k contribution was consistently reduced.

During the late 90s, when things became much more competitive in the industry, the company moved all their manufacturing overseas and laid off nearly all of the manufacturing folks.

The result - because so many low wage workers were reduced from payroll, I was no longer considered highly compensated and was able to contribute the full amount to my 401k from that point on.

Very nice incentive system don't you think

[Vent mode off]

Jim

 

[LOL!]

I've had 401(k) contributions refunded, so I know how to treat them on the tax return. KM take note as well.

You report income earned in 2006 on your 2006 tax return even if it was refunded to you in 2007. You may not get a 1099R for the refund until next year (i.e. 2008) for this 2006 income. If you do not report it on your 2006 return and the 1099R comes out in 2008, then you will have to file an amended 2006 return.

 

[REWahoo]

You report income earned in 2006 on your 2006 tax return even if it was refunded to you in 2007. You may not get a 1099R for the refund until next year (i.e. 2008) for this 2006 income. If you do not report it on your 2006 return and the 1099R comes out in 2008, then you will have to file an amended 2006 return.

No more calls, please. We have a winner.

 

[KM]

I've had 401(k) contributions refunded, so I know how to treat them on the tax return. KM take note as well.

You report income earned in 2006 on your 2006 tax return even if it was refunded to you in 2007. You may not get a 1099R for the refund until next year (i.e. 2008) for this 2006 income. If you do not report it on your 2006 return and the 1099R comes out in 2008, then you will have to file an amended 2006 return.

I was afraid that was going to be the case. I can determine the $$s before I file pretty easily. Can I just add it in, even if I don't have the 1099R yet?

Seems pointless to file an amended return for $100-$200 in income. They would pay more to audit me than they would recoup in taxes.....

 

[bssc]

Thanks for the information. We are looking at about 5000 being refunded so it isn't something that the IRS would take kindly to us forgetting.

I guess I will make sure to keep my 2006 return around because it looks like we will be filing an amended return.

 

[LOL!]

I guess I will make sure to keep my 2006 return around because it looks like we will be filing an amended return.

I routinely file for an extension and then submit my return in October rather than in April. By October most of this will be sorted out. That way I do not have to file amended returns. You must make sure to pay enough when you file for an extension so that you do not owe taxes when you finally file. Presumably you do not get a refund because you are practicing sound tax withholding. Or you can overpay with the extension (get the money by underwitholding from your paycheck).

 

[LOL!]

I was afraid that was going to be the case. I can determine the $$s before I file pretty easily. Can I just add it in, even if I don't have the 1099R yet?

Yes, you can just add it in even if you don't have the 1099R yet. It is technically an IRA distribution, so it will go on the line where IRA distributions are put, but there is no penalty. TurboTax will do this for you.

Edit to add: If the refund is already on your 2006 W2 then it is not technically an IRA distribution. It is possible that you get the refund in January before they calculate your W2, so check the numbers.

 

[Texas Proud]

Try this on on for size....

I was with my company back in the mid 80s... they allowed you to put in up to 20% of your income in the 401... I was NOT even close to highly compensated... but, a few years of this seemed to be good even though it was not much money...

Forward a couple of years and the plan determines I put in to high of a percentage, not dollar amount... so they REFUNDED me the excess money I put in for three years and sent me three new W-2s.... but, since they knew I would have to pay interest on the taxes... they also sent a check for the anticipated interest payment PLUS the taxes they thought you would have to pay on this interest....

So, my vote is the year it was earned no matter when you get it back..

 

[LOL!]

Ah-ha, the ol' corrected W2 routine.

But what about the taxes on the taxes on taxes .....?

 

[RedHawk]

Question from a dummy here. What is considered a highly compensated employee.? What difference does it make in regards to a 401k?

 

[Martha]

Question from a dummy here. What is considered a highly compensated employee.? What difference does it make in regards to a 401k?

Unless you have what is called a "safe harbor" 401k plan, the 401k contributions have to undergo discrimination testing each year. What I understand about discrimination testing is that the percentage contributions of highly compensated employees are compared to the percentage contributed by other employees. Highly compensated employees are those who are paid over $100,000(in 2006) plus people who own a certain ownership interest in the company. Or, I believe the company can define "highly compensated" as the top 20% earners. As an example, if the highly compensated employees are contributing 15% of their income, up to the maximum contribution, but the other employees are contributing only 2%, the company might flunk discrimation testing and the highly compensated have to reduce their percentage contribution.

We had this problem at our firm and fixed it by moving to a safe harbor plan and making fairly significant employer contributions to all employees. This allowed us to contribute the maximum to our 401(k) for the highly compensated.

 

[JustCurious]

We had this problem at our firm and fixed it by moving to a safe harbor plan and making fairly significant employer contributions to all employees. This allowed us to contribute the maximum to our 401(k) for the highly compensated.

It sounds like the HCE rules actually accomplished their intended purpose in your case.