Excess elective deferrals are taxable in the calendar year contributed. Earnings, through the date of correction on the excess deferrals are taxable in the year distributed.

Earnings calculation note:
As of plan year 2008, the calculation of earnings does not include GAP period earnings, so earnings on distributions made from January 1st to April 15th, for the preceding year, would only be calculated to December 31.

If not distributed by April 15th, the employee is taxed on both the excess pre-tax and Designated Roth deferrals in the year contributed and in the year distributed. The excess is treated as employer contribution and subject to withdrawal restrictions in accordance with Plan provisions. A late distribution is subject to the 10% penalty on early distribution, 20% withholding and spousal consent requirements.

Note: If excess occurs in plans of same or related employer, the employer risks disqualification of plan as section 401(a)(30) has been violated.
EPCRS is available for correction. The plan is able to self correct; generally, by distributing the excess deferral within two years after the year in which the excess deferral occurred. If this is insignificant, then the two-year limit may not apply.

If excess deferral distributed in the same year as it occurred, issue one 1099R for the total of the excess plus earnings. Use Code 8.

If the excess deferral is distributed between January 1 and April 15 of the year after the excess occurred, issue two 1099R Forms. One for the excess with a Code P for prior year, and, one for the earnings, with a Code 8. Participant must be notified that excess deferral is includible as income for the prior year and may require filing amended tax return.

Example
Participant, age 45, makes elective deferrals of $17,400 for 2009. Participant notified of excess deferral (may require filing amended tax return).

On Feb. 16, 2010, $900 excess plus $50 in earnings are distributed.

• W-2 is not changed. (But 1040 wages increased $900.)
  
• 2010 1099-R for $900 excess deferral, Code P (signifying prior year).
  
• 2010 1099-R for $50 earnings, Code 8

If distributed after April 15, the amount is taxable in the year in which the deferral is made though no 1099R needs to be issued for that year, and, it is taxable in the year the excess is distributed. A 1099R is to be issued for the excess and the earnings.

Thus, "double taxation" is the result of not correcting an excess deferral by the deadline of April 15th after the year it occurred. This rule also applies to a Roth 401(k) excess deferral and would also subject the Roth 401(k) to taxation again if not corrected until after April 15th. This is an exception to the normal tax treatment of Roth elective deferrals. If the participant's deferrals for the year are made up of both Roth and pre-tax deferrals, the participant may wish to remove the pre-tax as the excess deferrals.

Example
Using the prior example of $17,400 for 2009. But, distribution of $900 plus $60 in earning is made on June 13, 2010.

• W-2 elective not changed. On the 2009 Form 1040 wages, the $900 included as wages.
  
• No 1099-R issued for 2009, but the employee should be notified.
  
• 2010 Form 1099-R for $960, code 8, fully taxable.

Note: In none of the correction methods is the W-2 to be adjusted. The amount of deferrals that occured are to be reported on the W-2. However, the participant can only deduct the annual limit (including catch-up) for the year the excess deferral occurred, thus, the excess is taxable.

Excess deferral distributed to HCE is included in ADP test for year deferred.

Excess deferral distributed to NHCE is not included in ADP test if contributed under plan or plans of same or related employer.

If not distributed by April 15, excess deferrals are included in the annual additions calculation.

MHCO FAQs On handling losses, "double taxation" after April 15th and how excess deferrals can occur.

IRS 2010 Form 1099R Instructions
Information below is from Page 5 of the 1099R Instructions
"Excess deferrals. Excess deferrals under section 402(g) can occur in section 401(k) plans or section 403(b) plans or SARSEPs. If distributed by April 15 of the year following the year of deferral, the excess is taxable to the participant in the year of deferral (other than designated Roth contributions), but the earnings are taxable in the year distributed. Except for a SARSEP, if the distribution occurs after April 15, the excess is taxable in the year of deferral and the year distributed. The earnings are taxable in the year distributed. For a SARSEP, excess deferrals not withdrawn by April 15 are considered regular IRA contributions subject to the IRA contribution limits. Corrective distributions of excess deferrals are not subject to federal income tax withholding or social security and Medicare taxes. For losses on excess deferrals, see Losses below. See the regulations under section 457 for special rules for excess deferrals under governmental section 457(b) plans.

Losses. If a corrective distribution of an excess deferral is made in a year after the year of deferral and a net loss has been allocated to the excess deferral, report the corrective distribution amount in boxes 1 and 2a of Form 1099-R for the year of the distribution with the appropriate distribution code in box 7. If the excess deferrals consist of designated Roth account contributions, report the corrective distribution amount in box 1, 0 (zero) in box 2a, and the appropriate distribution code in box 7. However, taxpayers must include the total amount of the excess deferral (unadjusted for loss) in income in the year of deferral, and they may report a loss on the tax return for the year the corrective distribution is made"