The Employer Contribution Deduction Limit is the allowable deduction for employer contributions to a 401(k) plan in a single taxable year. In general, this limit is set to 25% of total compensation for all employees eligible to participate. Any contributions that exceed this limit are not deductible for tax purposes.
The limit is applied on an employer-wide basis, meaning it pertains to all contributions made for a single taxable year by the employer, its legally related affiliates, and all other qualified plans maintained by the employer during that year.
To ensure a plan stays within this limit, Guideline does not permit safe harbor nonelective contributions in excess of 25% of compensation and strongly encourages that matching formulas are limited to no more than 25% of compensation.
The determination of the deduction limit and the results of exceeding the limit are complicated. Plan sponsors must consult with a qualified tax advisor to ensure requirements are met. Sponsors are also responsible for working with their business tax advisor to report employer contributions and handle any applicable excise tax filings.
What if there are nondeductible contributions in a year?
Any amounts entered into the plan beyond the employer deduction limit are considered nondeductible contributions. While they are nondeductible, they cannot be removed from the plan. In addition, the plan will receive a penalty for amounts considered nondeductible. In these cases, Form 5330 must be completed and filed to report the amount of the nondeductible contributions, and the employer must pay a 10% excise tax on that amount.
The sponsor should consult with their tax advisor to accurately report the tax deduction and determine the appropriate treatment of the nondeductible contributions. Generally, they may be carried forward and deducted in the next taxable year, as long as it is within the deduction limit for that year.
Can the plan refund nondeductible employer contributions?
It is not permissible to refund or reverse nondeductible employer contributions. Contributions must remain in the plan and allocated to participants (as long as they do not exceed the limits under IRC §415).