Questions after IRS Guidance on Uncashed 401(K) Checks
A problem faced by the administrators of 401(k) and other retirement plans is what to do about plan participants who fail to cash distribution checks. This problem arises most commonly in connection with a plan that is required to make minimum distributions to a participant.
Required Minimum Distributions
Section 401(a)(9) of the tax code[1] requires an employer plan to begin making minimum distributions to a participant no later than the participant’s “required beginning date” which is defined as the April 1st of the year following the later of the year in which a participant reaches age 70-1/2 or, unless the participant is a 5% owner of the employer sponsoring the plan, the year in which the participant retires. A plan’s failure to make timely required minimum distributions is a defect that can potentially cause the plan to lose its tax qualification. In addition, a participant who does not receive required minimum distributions can be assessed a 50% excise tax on the amount of the unpaid distributions.
Revenue Ruling 2019-19
The Internal Revenue Service recently issued Revenue Ruling 2019-19, which provides guidance on the tax treatment of an uncashed check for a distribution that a plan is required to make. According to the ruling, a participant who receives a check for a required distribution, but does not cash it, is taxable on the amount of the check in the year that the check is sent to the participant.
The ruling states that the fact that the distribution check is not cashed does not alter the requirement that the distribution is subject to the tax withholding, unless an exception to withholding otherwise applies — such as in the case of a distribution that is less than $200 — and the distribution must be reported on a Form 1099-R for the year in which the distribution is made.
The ruling does not address, but similar reasoning would logically apply to, an uncashed check sent out by an IRA custodian for an IRA required minimum distribution.
Some Questions Not Addressed by Revenue Ruling 2019-19
The last paragraph of Revenue Ruling 2019-19 states that the IRS is continuing to analyze uncashed checks involving missing plan participants, a topic that presents nettlesome administrative issues for 401(k) and other plan administrators.
Consider the following example:
A plan sends out a required distribution check to a participant’s last known address. The check is not cashed, but it also is not returned. A footnote in Revenue Ruling 2019-19 states that whether the individual "keeps the check, sends it back, destroys it, or cashes it in a subsequent year is irrelevant."
Fair enough, but how can the plan administrator know whether the check was received and not cashed, or it simply never got to the participant because the participant was in a nursing home?
Also, the ruling obligates the employer to report the distribution to the IRS as taxable in the year the check was sent out. But what if the participant had moved, and the check is returned or forwarded?
Finding this out might take some time, and depending on when the check was issued, the plan administrator might have reported the distribution to the IRS as having been received in a year prior to the year when the participant actually got the check.
Missing Participants
Revenue Ruling 2019-19 provides a reminder of the complexities associated with a plan administrator’s obligation to locate missing participants.
The first challenge, as shown by the example above, is even knowing whether a plan participant is missing or simply not getting their mail, or even for some reason — perhaps arising from a participant’s unrelated third-party obligations — not wanting to be found.
If a plan administrator has doubts as to the whereabouts of a plan participant, the next question is what the plan administrator is required to do to find the participant. In this regard, the U.S. Department of Labor has stated that plan fiduciaries “must make reasonable efforts to locate missing participants or beneficiaries.” This view is expressed in the department's Field Assistance Bulletin No. 2014-01, which describes the minimum actions that must be taken to locate missing participants.
The field assistance bulletin states that a plan administrator should:
- Use certified mail to send a notice to the participant.
- Review other employee benefit plan and employer records for more up-to-date information.
- Send an inquiry to individuals such as the participant’s spouse and children for updated contact information for the participant.
- Use free electronic search tools.
The guidance in Field Assistance Bulletin No. 2014-01 is specifically directed at finding missing participants at the time of a plan termination. Presumably, the field assistance bulletin can be relied upon in the case of missing participants who are owed required minimum distributions prior to a plan’s termination.
That said, pending further guidance from the Department of Labor, a prudent plan administrator will want to consider and document additional steps to find a missing participant, such as using a paid search company, especially if the amount owed to the missing participant is substantial.
For the reasons stated above — the tax qualification risk to the plan and the excise tax risk to the participant — not making a required minimum distribution can have serious negative tax consequences. The IRS has indicated that the actions set forth in Field Assistance Bulletin No. 2014-01 are applicable for tax code purposes, at least in the context of payments to missing participants who are owed payments as part of a retroactive plan qualification correction. Hopefully this means that if a participant does not receive a required minimum distribution because the participant cannot be found, a plan administrator’s having followed the field assistance bulletin will provide a defense to any required minimum distribution tax problems.
Although Revenue ruling 2019-19 is helpful, as far as it goes, uncashed distribution checks and missing participants continue to pose significant uncertainties for the administrators of 401(k) and other employer retirement plans.
"Questions after IRS Guidance on Uncashed 401(K) Checks," by Daniel L. Morgan was published in Law360 on August 19, 2019. Reprinted with permission.