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Too Rich for a 401(k)?
by Kevin McCormally

This is the time of year a lot of readers get confused by what I call "boomerang 401(k) contributions." This happens when company retirement plans kick out some of the contributions made during the previous year by "highly compensated employees" -- generally those who make more than $90,000 a year.

Such "corrective distributions" are required if the plan discovers that highly-paid employees contributed too much of their salaries compared with the amount contributed by lower-paid workers. This discrimination testing is required by Congress to prevent the tax benefits of 401(k)s from going disproportionately to higher-paids. Because the test can't be completed until after the plan year closes, the checks for any excess contributions are mailed out after January 1.

But how to do you report that money on your tax return? It depends on the timing.

If a plan makes such a corrective distribution by March 15, then you report it as part of your 2003 salary -- even though it means reporting more salary than is shown on your W-2. After all, the W-2 amount was set assuming all the 401(k) money you contributed would avoid tax. The corrective distribution retroactively reduces the amount in the tax shelter and hikes your taxable pay.

If the company makes the payout after March 15, it counts as 2004 salary.

Oh, yeah: If you filed your 2003 return before you got a corrective distribution -- and you got the money by March 15 -- you're supposed to file an amended return using Form 1040X to report and pay tax on the extra money.