IRS Ruling on Uncashed Retirement Distribution Checks Leaves Unanswered Questions

The Internal Revenue Service recently warned missing or unresponsive retirement plan participants that uncashed distribution checks from qualified retirement plans are taxable.

Revenue Ruling 2019-19, issued on Aug. 14, applies to a participant who receives, but neither cashes nor rolls over, a distribution check.

"Because Internal Revenue Code Section 402(a) provides that any amount actually distributed from a qualified retirement plan is taxed under Section 72 in the year distributed (subject to the rollover rules), the ruling holds that the participant is taxed on the distribution check in the year she receives it, even if she does not cash it," Eversheds Sutherland attorneys explained in a recent alert.

The IRS held in its ruling that a mandatory distribution from a qualified plan "that is sent in one year, received in that year but not cashed in that year, is nevertheless taxable to the recipient in 2019 and subject to withholding and reporting by the payor," added Barry Klein, an attorney at Stradley Ronon's Philadelphia office.

The IRS guidance "helps payors understand their withholding obligations under very narrow circumstances," Klein said, and "appears to be a first step towards more complete guidance regarding uncashed checks."

While both Klein and Fred Reish, partner at Drinker Biddle & Reath in Los Angeles, opine that the IRS ruling isn't surprising, Klein notes that the guidance fails to address "harder questions such as what happens if the check is not received, is returned to the payor or is received in the following year? Or what happens with respect to missing participants?"

Payors, Klein continued, "usually must decide how to withhold and report when the check is sent, not when they later learn that the check was not received, was not cashed or that the participant cannot be found. Hopefully these questions will be addressed with additional guidance."

Reish adds that while he's been "interpreting existing law" to follow the IRS Aug. 14 guidance, "it's an unfortunate result, but it is, at least in my opinion, the correct application of the law."

This process, Reish explained, "usually starts with a participant making a request for a distribution. When the distribution is processed, one check is cut to the participant and another to the IRS for required tax withholding. The 'net'-after tax withholding-check is then mailed to the participant. For unexplainable reasons, the participant doesn't cash the check and, after six months, the check becomes 'stale.'"

Meanwhile, though, Reish continued, "the taxable distribution has been reported to the IRS and the withholding has been paid to the IRS. In theory, at least, that taxable income and the withholding is matched up to the taxpayer and should be matched with a tax return."

The Eversheds attorneys note that the IRS ruling goes on to provide that failure to cash the check has no effect on the employer's responsibility to withhold income tax on or report the distribution amount.

Problem Areas

The Eversheds attorneys hoped the ruling would have gone further.

The ruling "no doubt correctly reads Section 402(a), the statute has always created counter-intuitive results for distributions made at or near the end of the tax year that cannot be deposited until the following year," the attorneys state.

However, "It would be helpful for the IRS, as an exercise of administrative grace or otherwise, to provide a practical answer for that situation. The 'actual distribution' language in Section 402(a) effectively repeals constructive receipt principles for qualified plans, and some small latitude for year-end distributions would hardly run afoul of that Congressional purpose (even if some taxpayers might potentially use that latitude for gaming the system)," the attorneys state.

Revenue Ruling 2019-19 addresses the distribution check being "received" by the participant, but it "does not reach the more challenging set of related tax recognition, reporting and withholding issues that arise when plan disbursements are transmitted but not 'actually' received due to death or an incorrect address," the Eversheds attorneys state.

In fact, the attorneys continued, "employers and recordkeepers are rarely able to distinguish these situations from the facts in Rev. Rul. 2019-19 unless and until the check is returned as undeliverable, which can result in tax reporting issues. And any subsequent escheatment to the state of an unclaimed distribution raises its own interpretive and administrative complexities that also merit direction from the IRS."

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