4.   Qualified Plans

Table of Contents

Topics - This chapter discusses:

  • Kinds of plans

  • Qualification rules

  • Setting up a qualified plan

  • Minimum funding requirement

  • Contributions

  • Employer deduction

  • Elective deferrals (401(k) plans)

  • Qualified Roth contribution program

  • Distributions

  • Prohibited transactions

  • Reporting requirements

Useful Items - You may want to see:

Publications

  • 575 Pension and Annuity Income

  • 590 Individual Retirement Arrangements (IRAs)

  • 3066 Have you had your Check-up this year? for Retirement Plans

  • 3998 Choosing A Retirement Solution for Your Small Business

  • 4222 401(k) Plans for Small Businesses

  • 4530 Designated Roth Accounts under a 401(k), 403(b), or governmental 457(b) plans

  • 4531 401(k) Plan Checklist

  • 4674 Automatic Enrollment 401(k) Plans for Small Businesses

  • 4806 Profit Sharing Plans for Small Businesses

Forms (and Instructions)

www.dol.gov/ebsa/pdf/2013-5500.pdf

www.dol.gov/ebsa/pdf/2013-5500-SF.pdf

  • W-2 Wage and Tax Statement

  • Schedule K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc.

  • 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.

  • 1040 U.S. Individual Income Tax Return

  • Schedule C (Form 1040) Profit or Loss From Business

  • Schedule F (Form 1040) Profit or Loss From Farming

  • 5300 Application for Determination for Employee Benefit Plan

  • 5310 Application for Determination for Terminating Plan

  • 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts

  • 5330 Return of Excise Taxes Related to Employee Benefit Plans

  • 5500 Annual Return/Report of Employee Benefit Plan. For copies of this form, go to:

  • 5500-EZ Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan

  • 5500-SF Short Form Annual Return/Report of Small Employee Benefit Plan. For copies of this form, go to:

  • 8717 User Fee for Employee Plan Determination Letter Request

  • 8880 Credit for Qualified Retirement Savings Contributions

  • 8881 Credit for Small Employer Pension Plan Startup Costs

  • 8955-SSA Annual Registration Statement Identifying Separated Participants With Deferred Vested Benefits

These qualified retirement plans set up by self-employed individuals are sometimes called Keogh or H.R.10 plans. A sole proprietor or a partnership can set up one of these plans. A common-law employee or a partner cannot set up one of these plans. The plans described here can also be set up and maintained by employers that are corporations. All the rules discussed here apply to corporations except where specifically limited to the self-employed.

The plan must be for the exclusive benefit of employees or their beneficiaries. These qualified plans can include coverage for a self-employed individual.

As an employer, you can usually deduct, subject to limits, contributions you make to a qualified plan, including those made for your own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan.

Kinds of Plans

There are two basic kinds of qualified plans—defined contribution plans and defined benefit plans—and different rules apply to each. You can have more than one qualified plan, but your contributions to all the plans must not total more than the overall limits discussed under Contributions and Employer Deduction, later.

Defined Contribution Plan

A defined contribution plan provides an individual account for each participant in the plan. It provides benefits to a participant largely based on the amount contributed to that participant's account. Benefits are also affected by any income, expenses, gains, losses, and forfeitures of other accounts that may be allocated to an account. A defined contribution plan can be either a profit-sharing plan or a money purchase pension plan.

Profit-sharing plan.   Although it is called a “profit-sharing plan,” you do not actually have to make a business profit for the year in order to make a contribution (except for yourself if you are self-employed as discussed under Self-employed Individual, later). A profit-sharing plan can be set up to allow for discretionary employer contributions, meaning the amount contributed each year to the plan is not fixed. An employer may even make no contribution to the plan for a given year.

  The plan must provide a definite formula for allocating the contribution among the participants and for distributing the accumulated funds to the employees after they reach a certain age, after a fixed number of years, or upon certain other occurrences.

  In general, you can be more flexible in making contributions to a profit-sharing plan than to a money purchase pension plan (discussed next) or a defined benefit plan (discussed later).

Money purchase pension plan.   Contributions to a money purchase pension plan are fixed and are not based on your business profits. For example, if the plan requires that contributions be 10% of the participants' compensation without regard to whether you have profits (or the self-employed person has earned income), the plan is a money purchase pension plan. This applies even though the compensation of a self-employed individual as a participant is based on earned income derived from business profits.

Defined Benefit Plan

A defined benefit plan is any plan that is not a defined contribution plan. Contributions to a defined benefit plan are based on what is needed to provide definitely determinable benefits to plan participants. Actuarial assumptions and computations are required to figure these contributions. Generally, you will need continuing professional help to have a defined benefit plan.

Qualification Rules

To qualify for the tax benefits available to qualified plans, a plan must meet certain requirements (qualification rules) of the tax law. Generally, unless you write your own plan, the financial institution that provided your plan will take the continuing responsibility for meeting qualification rules that are later changed. The following is a brief overview of important qualification rules that generally have not yet been discussed. It is not intended to be all-inclusive. See Setting Up a Qualified Plan , later.

Generally, the following qualification rules also apply to a SIMPLE 401(k) retirement plan. A SIMPLE 401(k) plan is, however, not subject to the top-heavy plan rules and nondiscrimination rules if the plan satisfies the provisions discussed in chapter 3 under SIMPLE 401(k) Plan.

Plan assets must not be diverted.   Your plan must make it impossible for its assets to be used for, or diverted to, purposes other than the benefit of employees and their beneficiaries. As a general rule, the assets cannot be diverted to the employer.

Minimum coverage requirement must be met.   To be a qualified plan, a defined benefit plan must benefit at least the lesser of the following.
  1. 50 employees, or

  2. The greater of:

    1. 40% of all employees, or

    2. Two employees.

If there is only one employee, the plan must benefit that employee.

Contributions or benefits must not discriminate.   Under the plan, contributions or benefits to be provided must not discriminate in favor of highly compensated employees.

Contributions and benefits must not be more than certain limits.   Your plan must not provide for contributions or benefits that are more than certain limits. The limits apply to the annual contributions and other additions to the account of a participant in a defined contribution plan and to the annual benefit payable to a participant in a defined benefit plan. These limits are discussed later in this chapter under Contributions.

Minimum vesting standard must be met.   Your plan must satisfy certain requirements regarding when benefits vest. A benefit is vested (you have a fixed right to it) when it becomes nonforfeitable. A benefit is nonforfeitable if it cannot be lost upon the happening, or failure to happen, of any event. Special rules apply to forfeited benefit amounts. In defined contribution plans, forfeitures can be allocated to the accounts of remaining participants in a nondiscriminatory way, or they can be used to reduce your contributions.

  Forfeitures under a defined benefit plan cannot be used to increase the benefits any employee would otherwise receive under the plan. Forfeitures must be used instead to reduce employer contributions.

Participation.   In general, an employee must be allowed to participate in your plan if he or she meets both the following requirements.
  • Has reached age 21.

  • Has at least 1 year of service (2 years if the plan is not a 401(k) plan and provides that after not more than 2 years of service the employee has a nonforfeitable right to all his or her accrued benefit).

A plan cannot exclude an employee because he or she has reached a specified age.

Leased employee.   A leased employee, defined in chapter 1, who performs services for you (recipient of the services) is treated as your employee for certain plan qualification rules. These rules include those in all the following areas.
  • Nondiscrimination in coverage, contributions, and benefits.

  • Minimum age and service requirements.

  • Vesting.

  • Limits on contributions and benefits.

  • Top-heavy plan requirements.

Contributions or benefits provided by the leasing organization for services performed for you are treated as provided by you.

Benefit payment must begin when required.   Your plan must provide that, unless the participant chooses otherwise, the payment of benefits to the participant must begin within 60 days after the close of the latest of the following periods.
  • The plan year in which the participant reaches the earlier of age 65 or the normal retirement age specified in the plan.

  • The plan year in which the 10th anniversary of the year in which the participant began participating in the plan occurs.

  • The plan year in which the participant separates from service.

Early retirement.   Your plan can provide for payment of retirement benefits before the normal retirement age. If your plan offers an early retirement benefit, a participant who separates from service before satisfying the early retirement age requirement is entitled to that benefit if he or she meets both the following requirements.
  • Satisfies the service requirement for the early retirement benefit.

  • Separates from service with a nonforfeitable right to an accrued benefit. The benefit, which may be actuarially reduced, is payable when the early retirement age requirement is met.

Required minimum distributions.   Special rules require minimum annual distributions from qualified plans, generally beginning after age  
70½. See Required Distributions , under Distributions, later.

Survivor benefits.   Defined benefit and money purchase pension plans must provide automatic survivor benefits in both the following forms.
  • A qualified joint and survivor annuity for a vested participant who does not die before the annuity starting date.

  • A qualified pre-retirement survivor annuity for a vested participant who dies before the annuity starting date and who has a surviving spouse.

  The automatic survivor benefit also applies to any participant under a profit-sharing plan unless all the following conditions are met.
  • The participant does not choose benefits in the form of a life annuity.

  • The plan pays the full vested account balance to the participant's surviving spouse (or other beneficiary if the surviving spouse consents or if there is no surviving spouse) if the participant dies.

  • The plan is not a direct or indirect transferee of a plan that must provide automatic survivor benefits.

Loan secured by benefits.   If automatic survivor benefits are required for a spouse under a plan, he or she must consent to a loan that uses as security the accrued benefits in the plan.

Waiver of survivor benefits.   Each plan participant may be permitted to waive the joint and survivor annuity or the pre-retirement survivor annuity (or both), but only if the participant has the written consent of the spouse. The plan also must allow the participant to withdraw the waiver. The spouse's consent must be witnessed by a plan representative or notary public.

Waiver of 30-day waiting period before annuity starting date.    A plan may permit a participant to waive (with spousal consent) the 30-day minimum waiting period after a written explanation of the terms and conditions of a joint and survivor annuity is provided to each participant.

  The waiver is allowed only if the distribution begins more than 7 days after the written explanation is provided.

Involuntary cash-out of benefits not more than dollar limit.   A plan may provide for the immediate distribution of the participant's benefit under the plan if the present value of the benefit is not greater than $5,000.

  However, the distribution cannot be made after the annuity starting date unless the participant and the spouse or surviving spouse of a participant who died (if automatic survivor benefits are required for a spouse under the plan) consents in writing to the distribution. If the present value is greater than $5,000, the plan must have the written consent of the participant and the spouse or surviving spouse (if automatic survivor benefits are required for a spouse under the plan) for any immediate distribution of the benefit.

  Benefits attributable to rollover contributions and earnings on them can be ignored in determining the present value of these benefits.

  A plan must provide for the automatic rollover of any cash-out distribution of more than $1,000 to an individual retirement account or annuity, unless the participant chooses otherwise. A section 402(f) notice must be sent prior to an involuntary cash-out of an eligible rollover distribution. See Section 402(f) Notice under Distributions, later, for more details.

Consolidation, merger, or transfer of assets or liabilities.   Your plan must provide that, in the case of any merger or consolidation with, or transfer of assets or liabilities to, any other plan, each participant would (if the plan then terminated) receive a benefit equal to or more than the benefit he or she would have been entitled to just before the merger, etc. (if the plan had then terminated).

Benefits must not be assigned or alienated.   Your plan must provide that a participant's or beneficiary's benefits under the plan cannot be taken away by any legal or equitable proceeding except as provided below or pursuant to certain judgements or settlements against the participant for violations of plan rules.

Exception for certain loans.   A loan from the plan (not from a third party) to a participant or beneficiary is not treated as an assignment or alienation if the loan is secured by the participant's accrued nonforfeitable benefit and is exempt from the tax on prohibited transactions under section 4975(d)(1) or would be exempt if the participant were a disqualified person. A disqualified person is defined later in this chapter under Prohibited Transactions.

Exception for QDRO.   Compliance with a QDRO (qualified domestic relations order) does not result in a prohibited assignment or alienation of benefits.

  Payments to an alternate payee under a QDRO before the participant attains age 59½ are not subject to the 10% additional tax that would otherwise apply under certain circumstances. Benefits distributed to an alternate payee under a QDRO can be rolled over tax free to an individual retirement account or to an individual retirement annuity.

No benefit reduction for social security increases.   Your plan must not permit a benefit reduction for a post-separation increase in the social security benefit level or wage base for any participant or beneficiary who is receiving benefits under your plan, or who is separated from service and has nonforfeitable rights to benefits. This rule also applies to plans supplementing the benefits provided by other federal or state laws.

Elective deferrals must be limited.   If your plan provides for elective deferrals, it must limit those deferrals to the amount in effect for that particular year. See Limit on Elective Deferrals later in this chapter.

Top-heavy plan requirements.   A top-heavy plan is one that mainly favors partners, sole proprietors, and other key employees.

  A plan is top-heavy for a plan year if, for the preceding plan year, the total value of accrued benefits or account balances of key employees is more than 60% of the total value of accrued benefits or account balances of all employees. Additional requirements apply to a top-heavy plan primarily to provide minimum benefits or contributions for non-key employees covered by the plan.

  Most qualified plans, whether or not top-heavy, must contain provisions that meet the top-heavy requirements and will take effect in plan years in which the plans are top-heavy. These qualification requirements for top-heavy plans are explained in section 416 and its regulations.

SIMPLE and safe harbor 401(k) plan exception.   The top-heavy plan requirements do not apply to SIMPLE 401(k) plans, discussed earlier in chapter 3, or to safe harbor 401(k) plans that consist solely of safe harbor contributions, discussed later in this chapter. QACAs (discussed later) also are not subject to top-heavy requirements.

Setting Up a Qualified Plan

There are two basic steps in setting up a qualified plan. First you adopt a written plan. Then you invest the plan assets.

You, the employer, are responsible for setting up and maintaining the plan.

If you are self-employed, it is not necessary to have employees besides yourself to sponsor and set up a qualified plan. If you have employees, see Participation, under Qualification Rules, earlier.

Set-up deadline.   To take a deduction for contributions for a tax year, your plan must be set up (adopted) by the last day of that year (December 31 for calendar-year employers).

Credit for startup costs.   You may be able to claim a tax credit for part of the ordinary and necessary costs of starting a qualified plan that first became effective in 2013. For more information, see Credit for startup costs under Reminders, earlier.

Adopting a Written Plan

You must adopt a written plan. The plan can be an IRS-approved master or prototype plan offered by a sponsoring organization. Or it can be an individually designed plan.

Written plan requirement.   To qualify, the plan you set up must be in writing and must be communicated to your employees. The plan's provisions must be stated in the plan. It is not sufficient for the plan to merely refer to a requirement of the Internal Revenue Code.

Master or prototype plans.   Most qualified plans follow a standard form of plan (a master or prototype plan) approved by the IRS. Master and prototype plans are plans made available by plan providers for adoption by employers (including self-employed individuals). Under a master plan, a single trust or custodial account is established, as part of the plan, for the joint use of all adopting employers. Under a prototype plan, a separate trust or custodial account is established for each employer.

Plan providers.   The following organizations generally can provide IRS-approved master or prototype plans.
  • Banks (including some savings and loan associations and federally insured credit unions).

  • Trade or professional organizations.

  • Insurance companies.

  • Mutual funds.

Individually designed plan.   If you prefer, you can set up an individually designed plan to meet specific needs. Although advance IRS approval is not required, you can apply for approval by paying a fee and requesting a determination letter. You may need professional help for this. See Rev. Proc. 2014-6, 2014-1 I.R.B. 198, available at www.irs.gov/irb/2014-1_IRB/ar10.html, as annually updated, that may help you decide whether to apply for approval.

Internal Revenue Bulletins are available on the IRS website at IRS.gov They are also available at most IRS offices and at certain libraries.

User fee.   The fee mentioned earlier for requesting a determination letter does not apply to employers who have 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year. At least one of them must be a non-highly compensated employee participating in the plan. The fee does not apply to requests made by the later of the following dates.
  • The end of the 5th plan year the plan is in effect.

  • The end of any remedial amendment period for the plan that begins within the first 5 plan years.

The request cannot be made by the sponsor of a prototype or similar plan the sponsor intends to market to participating employers.

  For more information about whether the user fee applies, see Rev. Proc. 2014-8, 2014-1 I.R.B. 242, available at www.irs.gov/irb/2014-1_IRB/ar12.html, as may be annually updated; Notice 2003-49, 2003-32 I.R.B. 294, available at www.irs.gov/irb/2003-32_IRB/ar13.html; and Notice 2011-86, 2011-45 I.R.B. 698, available at www.irs.gov/irb/2011-45_IRB/ar11.html.

Investing Plan Assets

In setting up a qualified plan, you arrange how the plan's funds will be used to build its assets.

  • You can establish a trust or custodial account to invest the funds.

  • You, the trust, or the custodial account can buy an annuity contract from an insurance company. Life insurance can be included only if it is incidental to the retirement benefits.

You set up a trust by a legal instrument (written document). You may need professional help to do this.

You can set up a custodial account with a bank, savings and loan association, credit union, or other person who can act as the plan trustee.

You do not need a trust or custodial account, although you can have one, to invest the plan's funds in annuity contracts or face-amount certificates. If anyone other than a trustee holds them, however, the contracts or certificates must state they are not transferable.

Other plan requirements.   For information on other important plan requirements, see Qualification Rules , earlier in this chapter.

Minimum Funding Requirement

In general, if your plan is a money purchase pension plan or a defined benefit plan, you must actually pay enough into the plan to satisfy the minimum funding standard for each year. Determining the amount needed to satisfy the minimum funding standard for a defined benefit plan is complicated, and you should seek professional help in order to meet these contribution requirements. For information on this funding requirement, see section 412 and its regulations.

Quarterly installments of required contributions.   If your plan is a defined benefit plan subject to the minimum funding requirements, you generally must make quarterly installment payments of the required contributions. If you do not pay the full installments timely, you may have to pay interest on any underpayment for the period of the underpayment.

Due dates.   The due dates for the installments are 15 days after the end of each quarter. For a calendar-year plan, the installments are due April 15, July 15, October 15, and January 15 (of the following year).

Installment percentage.   Each quarterly installment must be 25% of the required annual payment.

Extended period for making contributions.   Additional contributions required to satisfy the minimum funding requirement for a plan year will be considered timely if made by 8½ months after the end of that year.

Contributions

A qualified plan is generally funded by your contributions. However, employees participating in the plan may be permitted to make contributions, and you may be permitted to make contributions on your own behalf. See Employee Contributions and Elective Deferrals later.

Contributions deadline.   You can make deductible contributions for a tax year up to the due date of your return (plus extensions) for that year.

Self-employed individual.   You can make contributions on behalf of yourself only if you have net earnings (compensation) from self-employment in the trade or business for which the plan was set up. Your net earnings must be from your personal services, not from your investments. If you have a net loss from self-employment, you cannot make contributions for yourself for the year, even if you can contribute for common-law employees based on their compensation.

Employer Contributions

There are certain limits on the contributions and other annual additions you can make each year for plan participants. There are also limits on the amount you can deduct. See Deduction Limits , later.

Limits on Contributions and Benefits

Your plan must provide that contributions or benefits cannot exceed certain limits. The limits differ depending on whether your plan is a defined contribution plan or a defined benefit plan.

Defined benefit plan.   For 2013, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of the following amounts.
  1. 100% of the participant's average compensation for his or her highest 3 consecutive calendar years.

  2. $205,000 ($210,000 for 2014).

Defined contribution plan.   For 2013, a defined contribution plan's annual contributions and other additions (excluding earnings) to the account of a participant cannot exceed the lesser of the following amounts.
  1. 100% of the participant's compensation.

  2. $51,000 ($52,000 for 2014).

  Catch-up contributions (discussed later under Limit on Elective Deferrals) are not subject to the above limit.

Employee Contributions

Participants may be permitted to make nondeductible contributions to a plan in addition to your contributions. Even though these employee contributions are not deductible, the earnings on them are tax free until distributed in later years. Also, these contributions must satisfy the actual contribution percentage (ACP) test of section 401(m)(2), a nondiscrimination test that applies to employee contributions and matching contributions. See Regulations sections 1.401(k)-2 and 1.401(m)-2 for further guidance relating to the nondiscrimination rules under sections 401(k) and 401(m).

When Contributions Are Considered Made

You generally apply your plan contributions to the year in which you make them. But you can apply them to the previous year if all the following requirements are met.

  1. You make them by the due date of your tax return for the previous year (plus extensions).

  2. The plan was established by the end of the previous year.

  3. The plan treats the contributions as though it had received them on the last day of the previous year.

  4. You do either of the following.

    1. You specify in writing to the plan administrator or trustee that the contributions apply to the previous year.

    2. You deduct the contributions on your tax return for the previous year. A partnership shows contributions for partners on Form 1065.

Employer's promissory note.   Your promissory note made out to the plan is not a payment that qualifies for the deduction. Also, issuing this note is a prohibited transaction subject to tax. See Prohibited Transactions , later.

Employer Deduction

You can usually deduct, subject to limits, contributions you make to a qualified plan, including those made for your own retirement. The contributions (and earnings and gains on them) are generally tax free until distributed by the plan.

Deduction Limits

The deduction limit for your contributions to a qualified plan depends on the kind of plan you have.

Defined contribution plans.   The deduction for contributions to a defined contribution plan (profit-sharing plan or money purchase pension plan) cannot be more than 25% of the compensation paid (or accrued) during the year to your eligible employees participating in the plan. If you are self-employed, you must reduce this limit in figuring the deduction for contributions you make for your own account. See Deduction Limit for Self-Employed Individuals , later.

  When figuring the deduction limit, the following rules apply.
  • Elective deferrals (discussed later) are not subject to the limit.

  • Compensation includes elective deferrals.

  • The maximum compensation that can be taken into account for each employee in 2013 is $255,000 ($260,000 for 2014).

Defined benefit plans.   The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Consequently, an actuary must figure your deduction limit.

  
In figuring the deduction for contributions, you cannot take into account any contributions or benefits that are more than the limits discussed earlier under Limits on Contributions and Benefits, earlier.

Table 4–1. Carryover of Excess Contributions Illustrated—Profit-Sharing Plan (000's omitted)

Year Participants' compensation Participants' share of required contribution (10% of annual profit) Deductible  
limit for current year (25% of compensation)
Contribution Excess contribution carryover 
used1
Total 
deduction including carryovers
Excess contribution carryover available at 
end of year
2010 $1,000 $100 $250 $100 $ 0 $100 $ 0
2011 400 165 100 165 0 100 65
2012 500 100 125 100 25 125 40
2013 600 100 150 100 40 140 0
 
1There were no carryovers from years before 2010.

Deduction Limit for Self-Employed Individuals

If you make contributions for yourself, you need to make a special computation to figure your maximum deduction for these contributions. Compensation is your net earnings from self-employment, defined in chapter 1. This definition takes into account both the following items.

  • The deduction for the deductible part of your self-employment tax.

  • The deduction for contributions on your behalf to the plan.

The deduction for your own contributions and your net earnings depend on each other. For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan. To do this, use either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in chapter 5. Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5.

Where To Deduct Contributions

Deduct the contributions you make for your common-law employees on your tax return. For example, sole proprietors deduct them on Schedule C (Form 1040) or Schedule F (Form 1040); partnerships deduct them on Form 1065; and corporations deduct them on Form 1120, or Form 1120S.

Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040. (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065) you get from the partnership.)

Carryover of Excess Contributions

If you contribute more to the plans than you can deduct for the year, you can carry over and deduct the difference in later years, combined with your contributions for those years. Your combined deduction in a later year is limited to 25% of the participating employees' compensation for that year. For purposes of this limit, a SEP is treated as a profit-sharing (defined contribution) plan. However, this percentage limit must be reduced to figure your maximum deduction for contributions you make for yourself. See Deduction Limit for Self-Employed Individuals, earlier. The amount you carry over and deduct may be subject to the excise tax discussed next.

Table 4-1, earlier, illustrates the carryover of excess contributions to a profit-sharing plan.

Excise Tax for Nondeductible (Excess) Contributions

If you contribute more than your deduction limit to a retirement plan, you have made nondeductible contributions and you may be liable for an excise tax. In general, a 10% excise tax applies to nondeductible contributions made to qualified pension and profit-sharing plans and to SEPs.

Special rule for self-employed individuals.   The 10% excise tax does not apply to any contribution made to meet the minimum funding requirements in a money purchase pension plan or a defined benefit plan. Even if that contribution is more than your earned income from the trade or business for which the plan is set up, the difference is not subject to this excise tax. See Minimum Funding Requirement , earlier.

Reporting the tax.   You must report the tax on your nondeductible contributions on Form 5330. Form 5330 includes a computation of the tax. See the separate instructions for completing the form.

Elective Deferrals (401(k) Plans)

Your qualified plan can include a cash or deferred arrangement under which participants can choose to have you contribute part of their before-tax compensation to the plan rather than receive the compensation in cash. A plan with this type of arrangement is popularly known as a “401(k) plan.” (As a self-employed individual participating in the plan, you can contribute part of your before-tax net earnings from the business.) This contribution is called an “elective deferral” because participants choose (elect) to defer receipt of the money.

In general, a qualified plan can include a cash or deferred arrangement only if the qualified plan is one of the following plans.

  • A profit-sharing plan.

  • A money purchase pension plan in existence on June 27, 1974, that included a salary reduction arrangement on that date.

Partnership.   A partnership can have a 401(k) plan.

Restriction on conditions of participation.   The plan cannot require, as a condition of participation, that an employee complete more than 1 year of service.

Matching contributions.   If your plan permits, you can make matching contributions for an employee who makes an elective deferral to your 401(k) plan. For example, the plan might provide that you will contribute 50 cents for each dollar your participating employees choose to defer under your 401(k) plan. Matching contributions are generally subject to the ACP test discussed earlier under Employee Contributions.

Nonelective contributions.   You can also make contributions (other than matching contributions) for your participating employees without giving them the choice to take cash instead. These are called nonelective contributions.

Employee compensation limit.   No more than $255,000 of the employee's compensation can be taken into account when figuring contributions other than elective deferrals in 2013. This limit is $260,000 in 2014.

SIMPLE 401(k) plan.   If you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year, you may be able to set up a SIMPLE 401(k) plan. A SIMPLE 401(k) plan is not subject to the nondiscrimination and top-heavy plan requirements discussed earlier under Qualification Rules. For details about SIMPLE 401(k) plans, see SIMPLE 401(k) Plan in chapter 3.

Distributions.   Certain rules apply to distributions from 401(k) plans. See Distributions From 401(k) Plans , later.

Limit on Elective Deferrals

There is a limit on the amount an employee can defer each year under these plans. This limit applies without regard to community property laws. Your plan must provide that your employees cannot defer more than the limit that applies for a particular year. For 2013 and 2014, the basic limit on elective deferrals is $17,500. This limit applies to all salary reduction contributions and elective deferrals. If, in conjunction with other plans, the deferral limit is exceeded, the difference is included in the employee's gross income.

Catch-up contributions.   A 401(k) plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. The catch-up contribution limit for 2013 and 2014 is $5,500. Elective deferrals are not treated as catch-up contributions for 2013 until they exceed the $17,500 limit, the actual deferral percentage (ADP) test limit of section 401(k)(3), or the plan limit (if any). However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts.
  • The catch-up contribution limit.

  • The excess of the participant's compensation over the elective deferrals that are not catch-up contributions.

Treatment of contributions.   Your contributions to your own 401(k) plan are generally deductible by you for the year they are contributed to the plan. Matching or nonelective contributions made to the plan are also deductible by you in the year of contribution. Your employees' elective deferrals other than designated Roth contributions are tax free until distributed from the plan. Elective deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax.

Forfeiture.   Employees have a nonforfeitable right at all times to their accrued benefit attributable to elective deferrals.

Reporting on Form W-2.   Do not include elective deferrals in the “Wages, tips, other compensation” box of Form W-2. You must, however, include them in the “Social security wages” and “Medicare wages and tips” boxes. You must also include them in box 12. Mark the “Retirement plan” checkbox in box 13. For more information, see the Form W-2 instructions.

Automatic Enrollment

Your 401(k) plan can have an automatic enrollment feature. Under this feature, you can automatically reduce an employee's pay by a fixed percentage and contribute that amount to the 401(k) plan on his or her behalf unless the employee affirmatively chooses not to have his or her pay reduced or chooses to have it reduced by a different percentage. These contributions are elective deferrals. An automatic enrollment feature will encourage employees' saving for retirement and will help your plan pass nondiscrimination testing (if applicable). For more information, see Publication 4674, Automatic Enrollment 401(k) Plans for Small Businesses.

Eligible automatic contribution arrangement.   Under an eligible automatic contribution arrangement (EACA), a participant is treated as having elected to have the employer make contributions in an amount equal to a uniform percentage of compensation. This automatic election will remain in place until the participant specifically elects not to have such deferral percentage made (or elects a different percentage). There is no required deferral percentage.

Withdrawals.   Under an EACA, you may allow participants to withdraw their automatic contributions to the plan if certain conditions are met.
  • The participant must elect the withdrawal no later than 90 days after the date of the first elective contributions under the EACA.

  • The participant must withdraw the entire amount of EACA default contributions, including any earnings thereon.

  If the plan allows withdrawals under the EACA, the amount of the withdrawal other than the amount of any designated Roth contributions must be included in the employee's gross income for the tax year in which the distribution is made. The additional 10% tax on early distributions will not apply to the distribution.

Notice requirement.   Under an EACA, employees must be given written notice of the terms of the EACA within a reasonable period of time before each plan year. The notice must be written in a manner calculated to be understood by the average employee and be sufficiently accurate and comprehensive in order to apprise the employee of his or her rights and obligations under the EACA. The notice must include an explanation of the employee's right to elect not to have elective contributions made on his or her behalf, or to elect a different percentage, and the employee must be given a reasonable period of time after receipt of the notice before the first elective contribution is made. The notice also must explain how contributions will be invested in the absence of an investment election by the employee.

Qualified automatic contribution arrangement.    A qualified automatic contribution arrangement (QACA) is a type of safe harbor plan. It contains an automatic enrollment feature, and mandatory employer contributions are required. If your plan includes a QACA, it will not be subject to the ADP test (discussed later) nor the top-heavy requirements (discussed earlier). Additionally, your plan will not be subject to the actual contribution percentage (ACP) test if certain additional requirements are met. Under a QACA, each employee who is eligible to participate in the plan will be treated as having elected to make elective deferral contributions equal to a certain default percentage of compensation. In order to not have default elective deferrals made, an employee must make an affirmative election specifying a deferral percentage (including zero, if desired). If an employee does not make an affirmative election, the default deferral percentage must meet the following conditions.
  1. It must be applied uniformly.

  2. It must not exceed 10%.

  3. It must be at least 3% in the first plan year it applies to an employee and through the end of the following year.

  4. It must increase to at least 4% in the following plan year.

  5. It must increase to at least 5% in the following plan year.

  6. It must increase to at least 6% in subsequent plan years.

Matching or nonelective contributions.   Under the terms of the QACA, you must make either matching or nonelective contributions according to the following terms.
  1. Matching contributions.You must make matching contributions on behalf of each non-highly compensated employee in the following amounts.

    1. An amount equal to 100% of elective deferrals, up to 1% of compensation.

    2. An amount equal to 50% of elective deferrals, from 1% up to 6% of compensation.

    Other formulas may be used as long as they are at least as favorable to non-highly compensated employees. The rate of matching contributions for highly compensated employees, including yourself, must not exceed the rates for non-highly compensated employees.

  2. Nonelective contributions.You must make nonelective contributions on behalf of every non-highly compensated employee eligible to participate in the plan, regardless of whether they elected to participate, in an amount equal to at least 3% of their compensation.

Vesting requirements.   All accrued benefits attributed to matching or nonelective contributions under the QACA must be 100% vested for all employees who complete 2 years of service. These contributions are subject to special withdrawal restrictions, discussed later.

Notice requirements.   Each employee eligible to participate in the QACA must receive written notice of their rights and obligations under the QACA, within a reasonable period before each plan year. The notice must be written in a manner calculated to be understood by the average employee, and it must be accurate and comprehensive. The notice must explain their right to elect not to have elective contributions made on their behalf, or to have contributions made at a different percentage than the default percentage. Additionally, the notice must explain how contributions will be invested in the absence of any investment election by the employee. The employee must have a reasonable period of time after receiving the notice to make such contribution and investment elections prior to the first contributions under the QACA.

Treatment of Excess Deferrals

If the total of an employee's deferrals is more than the limit for 2013, the employee can have the difference (called an excess deferral) paid out of any of the plans that permit these distributions. He or she must notify the plan by April 15, 2014 (or an earlier date specified in the plan), of the amount to be paid from each plan. The plan must then pay the employee that amount, plus earnings on the amount through the end of 2013, by April 15, 2014.

Excess withdrawn by April 15.   If the employee takes out the excess deferral by April 15, 2014, it is not reported again by including it in the employee's gross income for 2014. However, any income earned in 2013 on the excess deferral taken out is taxable in the tax year in which it is taken out. The distribution is not subject to the additional 10% tax on early distributions.

  If the employee takes out part of the excess deferral and the income on it, the distribution is treated as made proportionately from the excess deferral and the income.

  Even if the employee takes out the excess deferral by April 15, the amount will be considered for purposes of nondiscrimination testing requirements of the plan, unless the distributed amount is for a non-highly compensated employee who participates in only one employer's 401(k) plan or plans.

Excess not withdrawn by April 15.   If the employee does not take out the excess deferral by April 15, 2014, the excess, though taxable in 2013, is not included in the employee's cost basis in figuring the taxable amount of any eventual distributions under the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Also, if the employee's excess deferral is allowed to stay in the plan and the employee participates in no other employer's plan, the plan can be disqualified.

Reporting corrective distributions on Form 1099-R.   Report corrective distributions of excess deferrals (including any earnings) on Form 1099-R. For specific information about reporting corrective distributions, see the Instructions for Forms 1099-R and 5498.

Tax on excess contributions of highly compensated employees.   The law provides tests to detect discrimination in a plan. If tests, such as the actual deferral percentage test (ADP test) (see section 401(k)(3)) and the actual contribution percentage test (ACP test) (see section 401(m)(2)), show that contributions for highly compensated employees are more than the test limits for these contributions, the employer may have to pay a 10% excise tax. Report the tax on Form 5330. The ADP test does not apply to a safe harbor 401(k) plan (discussed next) nor to a QACA. Also, the ACP test does not apply to these plans if certain additional requirements are met.

  The tax for the year is 10% of the excess contributions for the plan year ending in your tax year. Excess contributions are elective deferrals, employee contributions, or employer matching or nonelective contributions that are more than the amount permitted under the ADP test or the ACP test.

  See Regulations sections 1.401(k)-2 and 1.401(m)-2 for further guidance relating to the nondiscrimination rules under sections 401(k) and 401(m).

  
If the plan fails the ADP or ACP testing, and the failure is not corrected by the end of the next plan year, the plan can be disqualified.

Safe harbor 401(k) plan.

If you meet the requirements for a safe harbor 401(k) plan, you do not have to satisfy the ADP test, nor the ACP test, if certain additional requirements are met. For your plan to be a safe harbor plan, you must meet the following conditions.

  1. Matching or nonelective contributions. You must make matching or nonelective contributions according to one of the following formulas.

    1. Matching contributions. You must make matching contributions according to the following rules.

      1. You must contribute an amount equal to 100% of each non-highly compensated employee's elective deferrals, up to 3% of compensation.

      2. You must contribute an amount equal to 50% of each non-highly compensated employee's elective deferrals, from 3% up to 5% of compensation.

      3. The rate of matching contributions for highly compensated employees, including yourself, must not exceed the rates for non-highly compensated employees.

    2. Nonelective contributions. You must make nonelective contributions, without regard to whether the employee made elective deferrals, on behalf of all non-highly compensated employees eligible to participate in the plan, equal to at least 3% of the employee's compensation.

    These mandatory matching and nonelective contributions must be immediately 100% vested and are subject to special withdrawal restrictions.

  2. Notice requirement. You must give eligible employees written notice of their rights and obligations with regard to contributions under the plan, within a reasonable period before the plan year.

The other requirements for a 401(k) plan, including withdrawal and vesting rules, must also be met for your plan to qualify as a safe harbor 401(k) plan.

Qualified Roth Contribution Program

Under this program an eligible employee can designate all or a portion of his or her elective deferrals as after-tax Roth contributions. Elective deferrals designated as Roth contributions must be maintained in a separate Roth account. However, unlike other elective deferrals, designated Roth contributions are not excluded from employees' gross income, but qualified distributions from a Roth account are excluded from employees' gross income.

Elective Deferrals

Under a qualified Roth contribution program, the amount of elective deferrals that an employee may designate as a Roth contribution is limited to the maximum amount of elective deferrals excludable from gross income for the year (for 2013 and 2014, $17,500 if under age 50 and $23,000 if age 50 or over) less the total amount of the employee's elective deferrals not designated as Roth contributions.

Designated Roth deferrals are treated the same as pre-tax elective deferrals for most purposes, including:

  • The annual individual elective deferral limit (total of all designated Roth contributions and traditional, pre-tax elective deferrals) of $17,500 for 2013 and 2014, with an additional $5,500 if age 50 or over for 2013 and 2014,

  • Determining the maximum employee and employer annual contributions of the lesser of 100% of compensation or $51,000 for 2013 ($52,000 for 2014),

  • Nondiscrimination testing,

  • Required distributions, and

  • Elective deferrals not taken into account for purposes of deduction limits.

Qualified Distributions

A qualified distribution is a distribution that is made after the employee's nonexclusion period and:

  • On or after the employee attains age  
    59½,

  • On account of the employee's being disabled, or

  • On or after the employee's death.

An employee's nonexclusion period for a plan is the 5-tax-year period beginning with the earlier of the following tax years.

  • The first tax year in which the employee made a contribution to his or her Roth account in the plan, or

  • If a rollover contribution was made to the employee's designated Roth account from a designated Roth account previously established for the employee under another plan, then the first tax year the employee made a designated Roth contribution to the previously established account.

Rollover.   Beginning September 28, 2010, a rollover from another account can be made to a designated Roth account in the same plan. For additional information on these in-plan Roth rollovers, see Notice 2010-84, 2010-51 I.R.B. 872, available at www.irs.gov/irb/2010-51_IRB/ar11.html, and Notice 2013-74. A distribution from a designated Roth account can only be rolled over to another designated Roth account or a Roth IRA. Rollover amounts do not apply toward the annual deferral limit.

Reporting Requirements

You must report a contribution to a Roth account on Form W-2 and a distribution from a Roth account on Form 1099-R. See the Form W-2 and 1099-R instructions for detailed information.

Distributions

Amounts paid to plan participants from a qualified plan are called distributions. Distributions may be nonperiodic, such as lump-sum distributions, or periodic, such as annuity payments. Also, certain loans may be treated as distributions. See Loans Treated as Distributions in Publication 575.

Required Distributions

A qualified plan must provide that each participant will either:

  • Receive his or her entire interest (benefits) in the plan by the required beginning date (defined later), or

  • Begin receiving regular periodic distributions by the required beginning date in annual amounts calculated to distribute the participant's entire interest (benefits) over his or her life expectancy or over the joint life expectancy of the participant and the designated beneficiary (or over a shorter period).

These distribution rules apply individually to each qualified plan. You cannot satisfy the requirement for one plan by taking a distribution from another. The plan must provide that these rules override any inconsistent distribution options previously offered.

Minimum distribution.   If the account balance of a qualified plan participant is to be distributed (other than as an annuity), the plan administrator must figure the minimum amount required to be distributed each distribution calendar year. This minimum is figured by dividing the account balance by the applicable life expectancy. The plan administrator can use the life expectancy tables in Appendix C of Publication 590 for this purpose. For more information on figuring the minimum distribution, see Tax on Excess Accumulation in Publication 575.

Required beginning date.   Generally, each participant must receive his or her entire benefits in the plan or begin to receive periodic distributions of benefits from the plan by the required beginning date.

  A participant must begin to receive distributions from his or her qualified retirement plan by April 1 of the first year after the later of the following years.
  1. Calendar year in which he or she reaches age 70½.

  2. Calendar year in which he or she retires from employment with the employer maintaining the plan.

However, the plan may require the participant to begin receiving distributions by April 1 of the year after the participant reaches age 70½ even if the participant has not retired.

  If the participant is a 5% owner of the employer maintaining the plan, the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reached age 70½. For more information, see Tax on Excess Accumulation in Publication 575.

Distributions after the starting year.   The distribution required to be made by April 1 is treated as a distribution for the starting year. (The starting year is the year in which the participant meets (1) or (2) above, whichever applies.) After the starting year, the participant must receive the required distribution for each year by December 31 of that year. If no distribution is made in the starting year, required distributions for 2 years must be made in the next year (one by April 1 and one by December 31).

Distributions after participant's death.   See Publication 575 for the special rules covering distributions made after the death of a participant.

Distributions From 401(k) Plans

Generally, distributions cannot be made until one of the following occurs.

  • The employee retires, dies, becomes disabled, or otherwise severs employment.

  • The plan ends and no other defined contribution plan is established or continued.

  • In the case of a 401(k) plan that is part of a profit-sharing plan, the employee reaches age 59½ or suffers financial hardship. For the rules on hardship distributions, including the limits on them, see Regulations section 1.401(k)-1(d).

  • The employee becomes eligible for a qualified reservist distribution (defined next).

Certain distributions listed above may be subject to the tax on early distributions discussed later.

Qualified reservist distributions.   A qualified reservist distribution is a distribution from an IRA or an elective deferral account made after September 11, 2001, to a military reservist or a member of the National Guard who has been called to active duty for at least 180 days or for an indefinite period. All or part of a qualified reservist distribution can be recontributed to an IRA. The additional 10% tax on early distributions does not apply to a qualified reservist distribution.

Tax Treatment of Distributions

Distributions from a qualified plan minus a prorated part of any cost basis are subject to income tax in the year they are distributed. Since most recipients have no cost basis, a distribution is generally fully taxable. An exception is a distribution that is properly rolled over as discussed under Rollover, next.

The tax treatment of distributions depends on whether they are made periodically over several years or life (periodic distributions) or are nonperiodic distributions. See Taxation of Periodic Payments and Taxation of Nonperiodic Payments in Publication 575 for a detailed description of how distributions are taxed, including the 10-year tax option or capital gain treatment of a lump-sum distribution.

Note.

A recipient of a distribution from a designated Roth account will have a cost basis since designated Roth contributions are made on an after-tax basis. Also, a distribution from a designated Roth account is entirely tax-free if certain conditions are met. See Qualified distributions under Qualified Roth Contribution Program, earlier.

Rollover.   The recipient of an eligible rollover distribution from a qualified plan can defer the tax on it by rolling it over into a traditional IRA or another eligible retirement plan. However, it may be subject to withholding as discussed under Withholding requirement, later. A rollover can also be made to a Roth IRA, in which case, any previously untaxed amounts are includible in gross income unless the rollover is from a designated Roth account.

Eligible rollover distribution.   This is a distribution of all or any part of an employee's balance in a qualified retirement plan that is not any of the following.
  1. A required minimum distribution. See Required Distributions , earlier.

  2. Any of a series of substantially equal payments made at least once a year over any of the following periods.

    1. The employee's life or life expectancy.

    2. The joint lives or life expectancies of the employee and beneficiary.

    3. A period of 10 years or longer.

  3. A hardship distribution.

  4. The portion of a distribution that represents the return of an employee's nondeductible contributions to the plan. See Employee Contributions , earlier, and Rollover of nontaxable amounts, next.

  5. Loans treated as distributions.

  6. Dividends on employer securities.

  7. The cost of any life insurance coverage provided under a qualified retirement plan.

  8. Similar items designated by the IRS in published guidance. See, for example, the Instructions for Forms 1099-R and 5498.

Rollover of nontaxable amounts.   You may be able to roll over the nontaxable part of a distribution to another qualified retirement plan or a section 403(b) plan, or to an IRA. If the rollover is to a qualified retirement plan or a section 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover, the transfer must be made through a direct (trustee-to-trustee) rollover. If the rollover is to an IRA, the transfer can be made by any rollover method.

Note.

A distribution from a designated Roth account can be rolled over to another designated Roth account or to a Roth IRA. If the rollover is to a Roth IRA, it can be rolled over by any rollover method, but if the rollover is to another designated Roth account, it must be rolled over directly (trustee-to-trustee).

More information.   For more information about rollovers, see Rollovers in Pubs. 575 and 590.

Withholding requirement.   If, during a year, a qualified plan pays to a participant one or more eligible rollover distributions (defined earlier) that are reasonably expected to total $200 or more, the payor must withhold 20% of the taxable portion of each distribution for federal income tax.

Exceptions.   If, instead of having the distribution paid to him or her, the participant chooses to have the plan pay it directly to an IRA or another eligible retirement plan (a direct rollover), no withholding is required.

  If the distribution is not an eligible rollover distribution, defined earlier, the 20% withholding requirement does not apply. Other withholding rules apply to distributions that are not eligible rollover distributions, such as long-term periodic distributions and required distributions (periodic or nonperiodic). However, the participant can choose not to have tax withheld from these distributions. If the participant does not make this choice, the following withholding rules apply.
  • For periodic distributions, withholding is based on their treatment as wages.

  • For nonperiodic distributions, 10% of the taxable part is withheld.

Estimated tax payments.   If no income tax is withheld or not enough tax is withheld, the recipient of a distribution may have to make estimated tax payments. For more information, see Withholding Tax and Estimated Tax in Publication 575.

Section 402(f) Notice.   If a distribution is an eligible rollover distribution, as defined earlier, you must provide a written notice to the recipient that explains the following rules regarding such distributions.
  1. That the distribution may be directly transferred to an eligible retirement plan and information about which distributions are eligible for this direct transfer.

  2. That tax will be withheld from the distribution if it is not directly transferred to an eligible retirement plan.

  3. That the distribution will not be subject to tax if transferred to an eligible retirement plan within 60 days after the date the recipient receives the distribution.

  4. Certain other rules that may be applicable.

  Notice 2009-68, 2009-39 I.R.B. 423, available at www.irs.gov/irb/2009-39_IRB/ar14.html, contains two updated safe harbor section 402(f) notices that plan administrators may provide recipients of eligible rollover distributions. If the plan allows in-plan Roth rollovers, the 402(f) notice must be amended to reflect this. Notice 2010-84 contains guidance on how to modify a 402(f) notice for in-plan Roth rollovers.

Timing of notice.   The notice generally must be provided no less than 30 days and no more than 180 days before the date of a distribution.

Method of notice.   The written notice must be provided individually to each distributee of an eligible rollover distribution. Posting of the notice is not sufficient. However, the written requirement may be satisfied through the use of electronic media if certain additional conditions are met. See Regulations section 1.401(a)-21.

Tax on failure to give notice.   Failure to give a 402(f) notice will result in a tax of $100 for each failure, with a total not exceeding $50,000 per calendar year. The tax will not be imposed if it is shown that such failure is due to reasonable cause and not to willful neglect.

Tax on Early Distributions

If a distribution is made to an employee under the plan before he or she reaches age 59½, the employee may have to pay a 10% additional tax on the distribution. This tax applies to the amount received that the employee must include in income.

Exceptions.   The 10% tax will not apply if distributions before age 59½ are made in any of the following circumstances.
  • Made to a beneficiary (or to the estate of the employee) on or after the death of the employee.

  • Made due to the employee having a qualifying disability.

  • Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his or her designated beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59½, whichever is the longer period.)

  • Made to an employee after separation from service if the separation occurred during or after the calendar year in which the employee reached age 55.

  • Made to an alternate payee under a QDRO.

  • Made to an employee for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the employee itemizes deductions).

  • Timely made to reduce excess contributions under a 401(k) plan.

  • Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions).

  • Timely made to reduce excess elective deferrals.

  • Made because of an IRS levy on the plan.

  • Made as a qualified reservist distribution.

  • Made as a permissible withdrawal from an EACA.

Reporting the tax.   To report the tax on early distributions, file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. See the form instructions for additional information about this tax.

Tax on Excess Benefits

If you are or have been a 5% owner of the business maintaining the plan, amounts you receive at any age that are more than the benefits provided for you under the plan formula are subject to an additional tax. This tax also applies to amounts received by your successor. The tax is 10% of the excess benefit includible in income.

To determine whether or not you are a 5% owner, see section 416.

Reporting the tax.   Include on Form 1040, line 60, any tax you owe for an excess benefit. On the dotted line next to the total, write “Sec. 72(m)(5)” and write in the amount.

Lump-sum distribution.   The amount subject to the additional tax is not eligible for the optional methods of figuring income tax on a lump-sum distribution. The optional methods are discussed under Lump-Sum Distributions in Publication 575.

Excise Tax on Reversion of Plan Assets

A 20% or 50% excise tax is generally imposed on the cash and fair market value of other property an employer receives directly or indirectly from a qualified plan. If you owe this tax, report it on Schedule I of Form 5330. See the form instructions for more information.

Notification of Significant Benefit Accrual Reduction

An employer or the plan will have to pay an excise tax if both the following occur.

  • A defined benefit plan or money purchase pension plan is amended to provide for a significant reduction in the rate of future benefit accrual.

  • The plan administrator fails to notify the affected individuals and the employee organizations representing them of the reduction in writing.

A plan amendment that eliminates or reduces any early retirement benefit or retirement-type subsidy reduces the rate of future benefit accrual.

The notice must be written in a manner calculated to be understood by the average plan participant and must provide enough information to allow each individual to understand the effect of the plan amendment. It must be provided within a reasonable time before the amendment takes effect.

The tax is $100 per participant or alternate payee for each day the notice is late, the total tax cannot be more than $500,000 during the tax year. It is imposed on the employer, or, in the case of a multi-employer plan, on the plan.

Prohibited Transactions

Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. (However, see Exemption , next.) If you are a disqualified person who takes part in a prohibited transaction, you must pay a tax (discussed later).

Prohibited transactions generally include the following transactions.

  1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.

  2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest.

  3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.

  4. Any of the following acts between the plan and a disqualified person.

    1. Selling, exchanging, or leasing property.

    2. Lending money or extending credit.

    3. Furnishing goods, services, or facilities.

Exemption.   Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. For other transactions that are exempt, see section 4975 and the related regulations.

Disqualified person.   You are a disqualified person if you are any of the following.
  1. A fiduciary of the plan.

  2. A person providing services to the plan.

  3. An employer, any of whose employees are covered by the plan.

  4. An employee organization, any of whose members are covered by the plan.

  5. Any direct or indirect owner of 50% or more of any of the following.

    1. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation that is an employer or employee organization described in (3) or (4).

    2. The capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4).

    3. The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4).

  6. A member of the family of any individual described in (1), (2), (3), or (5). (A member of a family is the spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.)

  7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50% or more of any of the following.

    1. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation.

    2. The capital interest or profits interest of a partnership.

    3. The beneficial interest of a trust or estate.

  8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7).

  9. A 10% or more (in capital or profits) partner or joint venturer of a person described in (3), (4), (5), or (7).

  10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a section 501(c)(22) trust is permitted to make payments under section 4223 of ERISA.

Tax on Prohibited Transactions

The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the taxable period. If the transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed. For information on correcting the transaction, see Correcting a prohibited transaction , later.

Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.

Amount involved.   The amount involved in a prohibited transaction is the greater of the following amounts.
  • The money and fair market value of any property given.

  • The money and fair market value of any property received.

  If services are performed, the amount involved is any excess compensation given or received.

Taxable period.   The taxable period starts on the transaction date and ends on the earliest of the following days.
  • The day the IRS mails a notice of deficiency for the tax.

  • The day the IRS assesses the tax.

  • The day the correction of the transaction is completed.

Payment of the 15% tax.   Pay the 15% tax with Form 5330.

Correcting a prohibited transaction.   If you are a disqualified person who participated in a prohibited transaction, you can avoid the 100% tax by correcting the transaction as soon as possible. Correcting the transaction means undoing it as much as you can without putting the plan in a worse financial position than if you had acted under the highest fiduciary standards.

Correction period.   If the prohibited transaction is not corrected during the taxable period, you usually have an additional 90 days after the day the IRS mails a notice of deficiency for the 100% tax to correct the transaction. This correction period (the taxable period plus the 90 days) can be extended if either of the following occurs.
  • The IRS grants reasonable time needed to correct the transaction.

  • You petition the Tax Court.

If you correct the transaction within this period, the IRS will abate, credit, or refund the 100% tax.

Reporting Requirements

You may have to file an annual return/report form by the last day of the 7th month after the plan year ends. See the following list of forms to choose the right form for your plan.

Form 5500-SF.   Form 5500-SF is a simplified annual reporting form. You can use Form 5500-SF if the plan meets all the following conditions.
  • The plan is a small plan (generally fewer than 100 participants at the beginning of the plan year).

  • The plan meets the conditions for being exempt from the requirements that the plan's books and records be audited by an independent qualified public accountant.

  • The plan has 100% of its assets invested in certain secure investments with a readily determinable fair value.

  • The plan holds no employer securities.

  • The plan is not a multiemployer plan.

  If your plan is required to file an annual return/report but is not eligible to file Form 5500-SF, the plan must file Form 5500 or Form 5500-EZ, as appropriate. For more details, see the Instructions for Form 5500-SF.

Form 5500-EZ.   You may be able to use Form 5500-EZ if the plan is a one-participant plan, as defined below.

One-participant plan.   Your plan is a one-participant plan if either of the following is true.
  • The plan covers only you (or you and your spouse) and you (or you and your spouse) own the entire business (whether incorporated or unincorporated).

  • The plan covers only one or more partners (or partner(s) and spouse(s)) in a business partnership.

Caution:   A one-participant plan may not file an annual return on Form 5500 for 2013. Every one-participant plan required to file an annual return for 2013 must file either Form 5500-EZ or, if eligible, Form 5500-SF. See the Instructions for Form 5500-EZ.

Form 5500-EZ not required.   If your one-participant plan (or plans) had total assets of $250,000 or less at the end of the plan year, then you do not have to file Form 5500-EZ for that plan year. All plans should file a Form 5500-EZ for the final plan year to show that all plan assets have been distributed.

Example.

You are a sole proprietor and your plan meets all the conditions for filing Form 5500-EZ. The total plan assets are more than $250,000. You should file Form 5500-EZ or Form 5500-SF, if eligible.

  
All one-participant plans should file Form 5500-EZ for their final plan year. The final plan year is the year in which distribution of all plan assets is completed.

Form 5500.   If you do not meet the requirements for filing Form 5500-EZ or Form 5500-SF and a return/report is required, you must file Form 5500.

Electronic filing of Forms 5500 and 5500-SF.   All Forms 5500 and 5500-SF are required to be filed electronically with the Department of Labor through EFAST2. “One-participant” plans will have the option of filing Form 5500-SF electronically, if eligible, rather than filing a Form 5500-EZ on paper with the IRS. For more information, see the Instructions for Forms 5500 and 5500-SF available at www.efast.dol.gov.

Form 5310.   If you terminate your plan and are the plan sponsor or plan administrator, you can file Form 5310. Your application must be accompanied by the appropriate user fee and Form 8717.

Form 8955-SSA.   Form 8955-SSA is used to report participants who are no longer covered by the plan but have a deferred vested benefit under the plan.

  Form 8955-SSA is filed with the IRS and can be filed electronically through the FIRE (Filing Information Returns Electronically) system.

More information.   For more information about reporting requirements, see the forms and their instructions.


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