Explain 401(k) Tardiness to the IRS

Q. I have been receiving mandatory distributions from my 401(k) plan for the last several years. The money is distributed by my former employer, usually sometime in December. However, this time, the check didn’t arrive until early January, and the Form 1099-R accompanying it noted that the distribution was for 1995. Will I be penalized for not receiving a 1994 distribution even though I have no control over when the distributions are made? -- A.L .

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A. Technically speaking, our experts say, you could be liable for the very penalty you fear. You should take your problem immediately to the administrators of your 401(k) plan and ask how they propose to handle the obvious error. Clearly, this situation wasn’t of your making and shouldn’t be yours alone to deal with.

At the least, our experts say, your plan administrator should offer to write to the IRS and explain why the 1994 mandatory distribution was not made until early 1995--and that the distribution was for 1994, not 1995. Hopefully, the IRS will accept the explanation and allow you to report the distribution as 1994 income and pay the usual income tax on it with your 1994 return. If not, and you are subject to a penalty for failing to receive the required distribution, you could, our experts continue, have a legitimate claim against the administrator of your 401(k) plan.

Rollover Rules for Savings Plans Differ

Q. Do the same options and IRS rules apply to rollovers into individual retirement accounts of 403(b) accounts as to rollovers of 401(k) funds into IRAs? R.R .

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A Generally speaking, no. There are notable differences in the rules for the two tax-deferred retirement savings plans.

Taxpayers leaving a company where they have 401(k) plans are allowed to move those funds into other tax-deferred savings plans, namely another 401(k) plan with the new employer, an IRA, a SEP-IRA or a Keogh plan. However, funds in a 403(b) annuity may be rolled over only to an IRA or another 403(b) account. And once 403(b) funds are transferred into an IRA, they may not be moved to another plan.

Why might you want to transfer your 403(b) funds into an IRA? The IRS allows taxpayers to invest their IRAs in a greater array of investment opportunities than are available to 403(b) account holders, who are essentially limited to annuities and other accounts offered by insurance companies. In addition, the withdrawal schedules for IRAs are considerably more flexible than those governing annuities. With an IRA you can essentially withdraw as much as you want, after you turn 59 1/2 and before you reach the mandatory distribution age of 70 1/2. With an annuity you are generally bound to a schedule of distributions over the payout period.

Stock Option Proceeds Not ‘Earned Income’

Q. My wife and I both exercised stock options from our former employer. I am retired and she still works. Is either of us required to pay Social Security or Medicare taxes on the proceeds generated by the transactions? -- G.A.A .

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A. Assuming that stock investing is not the principal business of either you or your wife, neither of you is required to pay Social Security or Medicare taxes on your stock gains. Why? Stock gains to taxpayers not principally engaged as stock traders are considered unearned income, and as such are not subject to either old-age tax. Of course, the proceeds are still subject to the usual income taxes and you should be sure that sufficient income taxes are withheld, or prepaid in a quarterly estimated tax return, to avoid state and federal penalties.

How to Take Losses on Defunct Shares

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Q.I purchased 200 shares of Pan Am Corp. in 1985 for $5.50 each. My commission charge was $40. These shares haven’t been traded since September, 1991, when their last published price was about 6 cents each. Obviously, my investment is worthless, but how do I write it off my tax return? -- P.G.S .

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A. If your broker is holding the shares on your behalf, which is unlikely given the time since the shares ceased trading, you can ask the brokerage to make a “tax sale.” In this case, and even though there is no longer a market for this stock, your broker would issue you a report noting that the shares had been “sold,” probably for $1. You would then be able to claim a loss, which you would calculate by deducting the proceeds from your total purchase price with commission fees. Your broker is not likely to charge you a commission for the tax sale, but be sure to ask first.

If you are holding the Pan Am stock certificate yourself, you will have to engage in a tax sale of another kind. Offer to sell your shares to a friend for a nominal sum, such as $1. Record the transaction carefully, noting your purchase price, commission and ultimate sales price. Compute and document the loss.

Please note, your loss is fully deductible against any investment gains you have for the year and up to $3,000 of ordinary income. If your loss exceeds that amount, you may carry over the remainder to future years. You may only deduct the loss for the year in which you actually sustained it. So, if you haven’t entered into a tax sale yet, it is too late to claim the loss on your 1994 tax return.

More on 401 (k) Plans

* Times on Demand has prepared a compilation from the Money Talk column of the most-asked questions and answers on 401 (k) plans. To order, call 808-8463, press *8630 and select Option 3. Order Item No. 8519. $5.41, plus 50 cents for delivery. Or send a check for $5.91 to Times on Demand Publications, P.O. Box 60395, Los Angeles, CA, 90060. Please allow two to three weeks for delivery.