EP Exam Projects - LESE Projects - Project #10 – Defined Contribution Form 5500EZ Examinations with Potential IRC §415 (c) Limit Excesses
The reason for this project was to obtain a snapshot view of qualified defined contribution plans (excluding ESOPS) where the average employer cash contribution received, per participant, as reported per Form 5500EZ entries, appeared to exceed the IRC §415(c) dollar limit. Note that IRC §415(c) provides maximums as to amounts that can be contributed and allocated to participants each year and is briefly discussed later in this article.
The question was whether the Form 5500EZ reporting of potential excess contributions was actually attributable to errors in reporting, attributable to cash contributions received during the plan year that were actually related to contributions spanning and attributable to more than one year, or attributable to contributions in excess of the IRC §415(c) dollar limit.
Specifically, we used the Form 5500EZ line item that reported cash contributions made during the plan year, and divided this amount by the line item(s) that reflected the total number of participants. We then identified those returns where the average cash contribution amount exceeded the current year’s IRC §415(c)(1)(A) dollar limit. Next, in conjunction with the maximum IRC §415(c)(1)(A) dollar limit for the year audited, we also factored in the potential for “catch-up” contributions (which are disregarded for IRC §415 limitations purposes) in profit sharing plans that could contain cash or deferred arrangements (i.e., IRC §401(k) arrangements). Those returns that still appeared to potentially exceed the IRC §415 limit were then included in our universe for potential selection for this project. We then made our random selections from this pool of returns.
This project commenced approximately March 2008 and utilized the focused examination concept to perform our examinations. As such, the pre-identified issues required to be considered by our examination agents were 1) Plan Qualification - Compliance with current tax law in form; 2) IRC §415 Limitations; and 3) Eligibility /Participation /Coverage (410). Under the focused examination concept, the scope of the examination requires the agent to determine compliance in three pre-identified areas. However, the agent has the discretion to expand their examination beyond the three pre-identified areas to any other areas based on their independent judgment as they deem warranted.
An initial sample of 49 plans (Form 5500EZ returns) was examined. Due to issues discovered, we expanded several audits by picking up the subsequent year Forms 5500EZ for examination. In addition, our agents solicited and secured 42 delinquent Form 5330 returns (most related to nondeductible contributions under IRC §4972, but a few related to minimum funding under IRC §4971). Our examiners also pursued four (4) Form 1040 income tax adjustments due to failure to properly include taxable distributions into income.
Nondeductible Employer Contributions: The most common issue, based on an analysis of all returns, was the making of excess non-deductible contributions. The inadvertent making of excess nondeductible contributions was generally caused by failing to properly monitor the amount of contribution to ensure that no amount allocated to any one participant exceeded the IRC §415 limit, and in some cases, failing to ensure that the contribution made for the tax year was within the IRC §404 maximum plan deductible limit (i.e., where the 25% overall compensation limit on deduction is less than the 100% of compensation limit under IRC §415 per participant).
This issue of the excess non-deductible contributions was pursued in six plans (representing approximately 12% of plans audited), resulting in the solicitation and examination of 37 Form 5330 returns and applicable payment of the IRC §4972 excise tax. The excise tax was equal to 10% of the nondeductible contributions made. We secured 35 delinquent Forms 5330. The remaining two Forms 5330 solicited and secured are subsequent year returns. We secured them before they became delinquent.
The Background section at the bottom of this page provides a brief discussion of the nondeductible employer contributions and IRC §4972.
IRC §415 Limitations Excesses: The focus of this project was the appearance of potential IRC §415 excess contributions based on Form 5500EZ reporting (i.e., reported employer contributions per participant appearing to exceed the IRC §415 limit). Based on examination results, this issue was actually present in six plans (representing approximately 12% of plans audited).
The reasons for the cause for the excess were varied, but the primary theme was lack of appropriate practices and procedures to ensure that the plan limits were not exceeded. One excess was due to the failure to properly include Roth contributions as part of the annual additions.
The Background section at the bottom of this page provides a brief discussion of the nondeductible employer contributions and IRC §415.
Late or Non-Amender: This issue was present in four of the plans audited (representing approximately 8% of plans audited). Two of these plans involved non-amender issues only, while the other two involved non-amender and other failures. The failures were resolved through Audit CAP, with the retroactive amendment secured and a tax sanctions paid.
There were other issues involving non-compliance addressed, but no specific or recurring trends. These areas of non-compliance included:
- Minimum Funding Deficiencies – This issue pertained to pre-2008 money purchase plans that involved underfunding, resulting in the securing of seven Forms 5330 and payment of excise tax under IRC §4971.
- Eligibility Error – This involved the failure to include eligible employees pursuant to plan terms. Issues involved the inadvertently application, in operation, of a 1 year of service requirement, even though the plans required immediate participation (i.e., no service requirement). Please be aware of your plan terms and follow those terms in operation.
- Income Tax Adjustments: There were several plans with instances of failure to properly include taxable distributions into income. As a result, agents made tax (discrepancy) adjustments to several Form 1040 returns.
Avoiding the Errors:
Discuss with your plan administrator or pension professional as to whether the plan is currently up to date with current law changes. Setting up operating procedures and appropriate internal controls for the plan is an important first step. If you need help, a benefits professional can help you set up a system that works for you and your retirement plan.
Consider an internal self-audit or review to ensure that the fiduciaries are properly handling plan assets. This review should consider fiduciary responsibilities as to plan investments under ERISA Act §404(a)(1). This would include the need to ensure plan assets are properly diversified, and that plan assets are invested with care, skill, prudence and diligence (i.e., prudent man rule). In addition, please file all returns related to the plan and trust’s operation in a timely manner. For example, if nondeductible contributions are made and not timely corrected, the employer is required to file the Form 5330 excise return with the applicable 10% excise tax, as well as ensure that that the excess contribution is not improperly deducted on the plan sponsor’s tax return.
If during a self-audit or other means, you discover that your plan was not operating in accordance with written plan provisions or in accordance with applicable laws and/or regulatory requirements, then you should consider availing yourself of our Employee Plans Compliance Resolution System (EPCRS). This page also contains links to assist you in finding, fixing and avoiding common plan errors.
IRC §4972 (Tax on nondeductible contributions to qualified employer plans):
IRC §4972 provides that nondeductible contributions (not timely corrected) made to qualified plans are subject to an excise tax equal to 10% of the nondeductible contribution (determined as of the close of the taxable year of the employer). This is a cumulative amount and due until corrected or otherwise deductible in a subsequent year. Forms 5330 should be filed to report any nondeductible employer contributions, along with the payment of the applicable 10% excise tax.
For purposes of this excise tax, note that any excess contribution for a taxable year that is distributed back to the employer on or before the due date for filing the taxable return plus extensions, as provided in IRC §404(a)(6) for such taxable year, may be disregarded.
Note that this excise tax is in addition to an adjustment to the plan sponsor’s tax return to disallow the excess deduction.
IRC §415 Limitations:
Generally, qualified plans are not permitted to allocate contributions and other additions to plan participants in excess of the IRC §415 limitations. This limit applies to each participant, and is based on annual additions made during the plan’s Limitation Year.
The limit on annual additions made and allocated to each participant in defined contribution plans, as provided by IRC §415(c), is the lesser of 1) the IRC §415 dollar limit or 2) 100 percent of the participant’s compensation for the Limitation Year. For purposes of this limit, the Limitation Year is a 12 consecutive month period that will be defined within the plan document, but is generally the same as the Plan Year.
Annual Additions, for purposes of this limit, generally include all employer contributions, employee contributions and forfeitures allocated to the participant. Finally, compensation is specifically defined under IRC §415(c)(3), with certain exclusions such as rollovers, with this definition required to be clearly set out within the plan document.
In addition, “ catch-up” contributions made to cash or deferred arrangements (i.e., IRC §401(k) plans) for individuals age 50 or over are not considered annual additions.
The consequences of exceeding the IRC §415 limit are that the plan will fail to retain its status as a qualified plan, resulting in potential adverse tax consequences to the employer, trust and participants, unless certain corrective actions are timely made. In addition, IRC §404(j) provides that employer contributions made that exceed the IRC §415 limits are not deductible.
For more detail with respect to the IRC §415 limitations, it is recommended that you consult with your local pension professional.