11.4 Distribution Tax Reporting: Form 1099-R Codes, Form 945, In-Kind Distributions & Net Unrealized Appreciation

The Reporting Half of Every Distribution

A distribution is not finished when the check clears. IRC §6047(d) and the accompanying regulations require the payor to report it, and reporting errors generate participant tax notices, IRS penalty assessments, and amended returns. The QKA exam tests the mechanics because the administrator — not the participant and not the CPA — is the one who codes the form.

Form 1099-R: Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans

When It Is Required

Any designated distribution of $10 or more. This includes direct rollovers (reported, though not taxable), corrective distributions, deemed distributions of defaulted loans, and RMDs.

Deadlines

The Boxes That Matter

Distribution Codes Worth Memorizing

Two pairings drive most exam questions:

• Code 8 vs. Code P on ADP/ACP corrective distributions. Under current law, excess contributions are taxable in the year distributed, so a correction paid in 2027 for the 2026 plan year uses Code 8 for the 2027 tax year. Code P survives for the §402(g) excess deferral corrective distribution paid by April 15, which is taxable in the year of deferral.
• Code L vs. Code M. A deemed distribution (Code L) is a taxable event on a loan that remains a plan asset and is not eligible for rollover. A plan loan offset (Code M) reduces the account when a real distributable event occurs, and is an eligible rollover distribution — with the repayment window extended to the participant's tax filing deadline including extensions under the Tax Cuts and Jobs Act.

Form 945: Annual Return of Withheld Federal Income Tax

Federal income tax withheld from plan distributions is non-payroll withholding. It is not reported on Form 941.

A mismatch between aggregate 1099-R Box 4 and Form 945 is one of the most common IRS notices a TPA has to resolve.

Distributions of Non-Cash Assets

A plan may distribute property — real estate, a promissory note, employer stock, or an insurance contract. The rules:

1. Taxation is on fair market value on the date of distribution, not on the plan's cost basis, and not on a later sale price.
2. Mandatory 20% withholding still applies if the distribution is an eligible rollover distribution. Because the plan cannot withhold from a parcel of real estate, the withholding must come from a cash component of the same distribution, or the participant must supply cash. If the entire distribution is property other than employer securities and no cash is available, the plan may not be able to satisfy the withholding requirement — a practical reason plans liquidate before distributing.
3. Employer securities are treated specially for withholding. The 20% withholding requirement does not apply to the portion of a distribution consisting of employer securities, to the extent of the net unrealized appreciation excluded from income.
4. A direct rollover of property is permitted — the receiving plan or IRA must accept the asset in kind.
5. Valuation must be defensible. Distributing a hard-to-value asset requires an independent appraisal; a self-reported value is a fiduciary exposure and a prohibited transaction risk if the asset is distributed to a party in interest.

Net Unrealized Appreciation: IRC §402(e)(4)

NUA is the excess of the fair market value of employer securities at distribution over the plan's cost basis in those securities.

The rule: if employer securities are distributed as part of a lump sum distribution, the NUA is excluded from income at the time of distribution. Only the cost basis is taxed then, as ordinary income. When the participant later sells the securities, the NUA is taxed as long-term capital gain regardless of how long the participant actually held them after distribution.

"Lump sum distribution" is a defined term: the entire balance to the credit of the participant, distributed within a single taxable year, on account of death, disability (for the self-employed), separation from service, or attainment of age 59½.

Worked example. Renata separates from service at 61. Her account holds employer stock with a plan cost basis of $40,000 and a fair market value of $260,000, plus $150,000 of mutual funds. She takes her entire balance in one taxable year, rolling the mutual funds to an IRA and taking the stock in kind.

Item	Amount	Treatment
Plan cost basis in the stock	$40,000	Ordinary income in the year of distribution
Net unrealized appreciation	$220,000	Excluded now; long-term capital gain when sold
Mutual funds direct-rolled to IRA	$150,000	Not taxable; Code G
Reported in Box 6 of the 1099-R	$220,000	NUA

If Renata later sells the stock for $300,000, the $220,000 NUA is long-term capital gain and the additional $40,000 of post-distribution appreciation is capital gain based on her actual holding period. Had she rolled the stock into an IRA instead, the entire $260,000 would eventually have come out as ordinary income — which is why NUA planning matters and why the election is irrevocable in practice.

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Common ASPPA QKA Exam Traps

• Trap 1 — Reporting withholding on Form 941. Plan withholding is non-payroll and belongs on Form 945.
• Trap 2 — Code 8 vs. Code P. ADP/ACP excess contributions are taxable in the year distributed (Code 8); §402(g) excess deferrals corrected by April 15 use Code P.
• Trap 3 — Code L vs. Code M. Deemed distributions are not rollable; loan offsets are.
• Trap 4 — Using the beneficiary's age to code a death distribution. Death distributions are Code 4 regardless of age.
• Trap 5 — Taxing NUA at distribution. Only the cost basis is taxed then.
• Trap 6 — Assuming NUA survives a rollover. Rolling the securities into an IRA destroys the NUA benefit permanently.
• Trap 7 — Forgetting that property distributions are valued at FMV on the distribution date, not at plan cost.