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While preparing an amended 2005 return I found that my client had included in his 2005 income the return of excess contributions to his 401(k) in 2004. Obviously this distribution should have been included on an amended 2004 return. The 1099R was coded P but the client did his own return and didn't realize that he should not include it in 2005 income.

My question is should I remove the excess contributions from his 2005 return since it needs to be amended for an entirely different reason and amend his 2004 return?

If I do that he will get a refund for 2005 and will owe for 2004. Evidently the IRS isn't going to catch his error - or at least doesn't want to pursue it.

Should I just leave it the way it is? He did pay tax on the returned contributions although not in the correct year.

Thanks in advance for your advice.

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You've got a couple more issues there.

Do you know when the 2004 return was originally filed? If it was filed on time and without an extension, the statute of limitations has expired on that year. It would have run on 4/15/08. But if the original return was on extension or filed late, the statute might still be open. All that means is that the IRS may not be able to assess additional tax for 2004.

Next, this distribution was reported on a 1099. So the IRS knows about it and their computers should typically have run their matching routines on it. Which means they may have already caught this error and sent the taxpayer a bill. I've found that a lot of people will not question these bills and just pay them if the bill is fairly small. So another possibility is that the IRS caught the missing income in 2004, sent them a bill, and they paid it.

However, in that scenario, the IRS would not have changed the 2005 return with the extra income.

So I'd give some consideration to taking the income off the 2005 return and NOT changing the 2004 return.

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Thank you Peter. I think I'll leave the income on the 2005 return since he really should pay tax on it (he never got a bill for the tax) unless he insists on amending the 2004 return. He's a bit obsessive compulsive and wants things the way they should be.
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