This Issue Snapshot discusses the timing rules of IRC sections 404(a)(6) and 415 and considers how these rules apply to employers who establish a new 401(k) plan after the end of the tax year. IRC sections and Treas. regulations IRC section 401(b)(2) IRC section 401(k) IRC section 404(a)(3) IRC section 404(a)(6) Treas. Reg. 1.401-1(a)(2) Treas. Reg. 1.401(k)-1(a)(3)(iii) Treas. Reg. 1.415(c)-1(b)(6)(i)(B) Resources Division O of the Further Consolidated Appropriations Act, 2020, Pub. L. 116-94, 133 Stat. 2534 (2019), known as the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) Division T of the Consolidated Appropriations Act, 2023, Pub. L. 117-328, 136 Stat. 4459 (2022), known as the SECURE 2.0 Act of 2022 (SECURE 2.0 Act) Revenue Ruling 66-144, 1966-1 C.B. 91 Revenue Ruling 76-28, 1976-1 C.B. 106 Revenue Ruling 90-105, 1990-2 C.B. 69 Analysis Several different Code sections apply in determining whether a retirement plan may be retroactively established for an employer's taxable year and whether plan contributions after the end of the taxable year are allocable to and deductible in the prior year. With respect to a 401(k) plan, separate timing rules apply for purposes of: Establishing a plan, Making elective deferrals to the plan, Making deductible profit-sharing or matching contributions to the plan, and Allocating contributions to employees' accounts in the plan. Establishing a plan Before contributions can be made or deducted, a plan must be established. See Treas. Reg. 1.401-1(a)(2). Prior to the enactment of the SECURE Act, an employer was required to adopt a written retirement plan document no later than the last day of its initial plan year. See Treas. Reg. 1.401(b)-1(a). For taxable years beginning after December 31, 2019, IRC section 401(b)(2) permits an employer to establish a plan retroactively, provided it's adopted by the due date, including extensions, for filing the employer's tax return for the taxable year of adoption, and the employer elects to treat the plan as having been adopted as of the last day of that prior taxable year. IRC section 401(b)(2), as amended by section 201 of the SECURE Act. For example, a calendar-year employer could decide in March of 2023 to establish a plan retroactively for the 2022 calendar year. If the plan is established prior to the due date, including extensions, of the employer's 2022 tax return, IRC section 401(b)(2) allows the employer to establish the plan, enabling employees to receive contributions on account of 2022 compensation. The employer would also be entitled to a deduction on its 2022 tax return. Some limits do apply to the types of plan contributions that can be made retroactively. See Timing of Elective Deferrals, below. Once established, an employer periodically amends plan terms retroactively as necessary to maintain plan qualification, or to accommodate design choices of the employer. IRC section 401(b)(1). See also Rev. Proc. 2022-40, 2022-47 I.R.B. 487. Timing of elective deferrals A qualified cash or deferred arrangement (CODA) is an arrangement which allows eligible employees to make an election between receiving cash compensation or deferring compensation into the plan. Treas. Reg. 1.401(k)-1(e)(2). In general, this cash or deferred election can only be made with respect to an amount that is not currently available to the employee on the date of the election. Treas. Reg. 1.401(k)-1(a)(3)(iii). Compensation is considered currently available if the compensation has already been paid or the employee is currently able to receive the cash at the employee's discretion. Treas. Reg. 1.401(k)-1(a)(3)(iv). Accordingly, a CODA must be established before compensation can be deferred, and retroactive elective deferrals are not generally permitted. A plan is considered established as of the later of: The date the arrangement is adopted, or The date the arrangement is effective. An exception to this general timing rule is available for new single-member 401(k) plans. Effective with plan years beginning after the date of the enactment of the SECURE 2.0 Act, an individual who owns the entire interest in an unincorporated business, and who is the only employee of such trade or business, can adopt a new 401(k) plan after the end of the taxable year and, for the first year only, can elect to defer net earnings from self-employment in the prior year as late as the due date for the individual’s tax return (determined without regard to any extensions). IRC section 401(b)(2), as amended by section 317 of the SECURE 2.0 Act. Timing of deductible profit-sharing or matching contributions An employer is generally permitted to deduct profit-sharing or matching contributions made after the close of the tax year but before the due date of the employer’s tax return, including extensions. IRC section 404(a)(6). While IRC section 404(a)(3)(A)(i) limits the deduction to contributions in the taxable year when paid, the employer is deemed to have paid contributions on the last day of the preceding tax year if certain conditions are met. Retroactive payment is assumed if the employer treats the contribution as having been made in that tax year for allocation purposes and actually pays the contribution to the plan not later than the due date of the employer’s tax return, including extensions. See IRC section 404(a)(6) and Rev. Rul. 76-28. This rule applies to both cash and accrual basis employers. For example, if the due date of the employer's calendar-year 2022 Form 1040 or Form 1120 is April 18, 2023, with an extended due date of October 16, 2023 (after the automatic six-month extension), the employer has until October 16, 2023, to make a 2022 profit-sharing contribution and deduct it on their 2022 return. If the employer files their 2022 Form 1120 on June 1, 2023, they would still have until October 16, 2023, to make the profit-sharing contribution and deduct it on their 2022 return. See Rev. Rul. 66-144. Even if the employer filed on or before April 18, 2023, they would still have until October 16, 2023, their extended due date, to make deductible profit-sharing contributions for 2022. Matching contributions are employer contributions made on account of an employee contribution or elective deferral. Treas. Reg. 1.401(m)-1(a)(2)(i). Because they are tied to deferrals, matching contributions cannot be made on account of compensation earned after the end of the taxable year. See Rev. Rul. 90-105. Timing of allocations to participant accounts Employer contributions are not treated as credited to a participant's account for a particular limitation year unless the contributions are actually paid to the plan no later than 30 days after the end of the IRC section 404(a)(6) period (the extended due date of the employer's tax return). Treas. Reg. 1.415(c)-1(b)(6)(i)(B). Although the contributions can be allocated to participants if paid within 30 days after the end of this period, they can't be deducted unless they are paid before the end of the IRC section 404(a)(6) period. Contributions paid to the plan and allocated after the extended due date of the employer's tax return would be deductible in the following plan year, subject to the limitations of IRC section 404(a)(3). For example, if the extended due date for the employer's 2022 Form 1120 is October 16, 2023, the employer would have until November 15, 2023 (30 days after the IRC section 404(a)(6) date), to make the contribution and allocate it to the 2022 plan year participants. However, while the contribution can be treated as a 2022 annual addition for purposes of IRC section 415 if allocated to participants by November 15, 2023, this contribution would not be deductible on the 2022 Form 1120 since the payment was not made by the end of the IRC section 404(a)(6) date of October 16, 2023. However, the contribution would be deductible on the 2023 Form 1120, provided that, when combined with any other 2023 contributions deducted for the 2023 plan year, it does not exceed the IRC section 404(a)(3) deductible limit (25% of compensation) for 2023. For example, if the 2022 profit-sharing contribution made after the IRC section 404(a)(6) date of October 16, 2023, was $30,000, that would need to be added to any 2023 contributions when determining if the 2023 deductible limits were exceeded. Examples The following examples illustrate these concepts. All assume plan and tax years are on a calendar year basis. Example 1 Aardvark Corp. decided to offer a retirement plan for its employees. After meeting with a plan consultant on February 22, 2023, it decided it wanted to make the plan effective for 2022. The plan document was signed on February 25, 2023, with an effective date of January 1, 2022. Aardvark can make a profit-sharing contribution and deduct it on its 2022 federal income tax return, provided the contribution is (1) allocated as a 2022 contribution, (2) paid before the employer's tax return due date (including extensions), and (3) is within the 2022 IRC section 415 limits and the IRC section 404(a)(3) contribution limitation based on 25% of 2022 participant compensation. Example 2 Bear Corp. timely filed for an extension for their 2022 Form 1120, extending the filing due date from April 18, 2023, to October 16, 2023. Bear Corp. filed their Form 1120 on August 8, 2023, and deducted $80,000 for its 2022 profit-sharing contribution, which was less than the IRC section 404(a)(3) deductible limit of 25% of eligible participant compensation. Bear Corp. then contributed this $80,000 to the profit-sharing plan by the October 16, 2023, IRC section 404(a)(6) deadline. In this case, the return was filed with an anticipatory deduction because the reflected contribution amount had not yet been paid as of the date of filing. However, because both filing and payment preceded the extended due date of the return, the deduction is timely and allowable. Example 3 The due date of Coyote Corp's 2022 Form 1120 was extended to October 16, 2023. Coyote Corp timely filed their Form 1120 on October 14, 2023, reflecting a $90,000 profit-sharing deduction. However, this contribution was not actually paid to the plan and allocated to employees until November 4, 2023. The contribution was not timely for deduction purposes on their 2022 Form 1120, but it was timely to meet the 30-day allocation rule provided by Treas. Reg. 1.415(c)-1(b)(6)(i)(B). Therefore, although the contribution could be allocated to participants for the 2022 plan year and was evaluated based on 2022 IRC section 415 limits, the $90,000 contribution would not be deductible on the 2022 Form 1120 filing. Instead, it might be deductible on the 2023 Form 1120, subject to the IRC section 404(a)(3) limit, if this amount, when added to any other 2023 profit-sharing contribution, is within the 2023 25% IRC section 404(a)(3) deductible limit. If 25% of Coyote Corp's eligible participant compensation in 2023 was $150,000, the deductible contributions for 2023 contributions could not exceed $60,000 ($150,000 – the $90,000 year-2022 contribution made after the IRC section 404(a)(6) date = $60,000). If the combined contributions for 2023 did exceed $150,000, a 10% excise tax under IRC section 4972 would be due on the excess contribution amount, reportable on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans. This is true whether or not Coyote Corp actually deducted the excess amount on its 2023 return. Example 4 Dromedary Corp. maintains an existing profit-sharing plan. On May 1, 2022, Dromedary decides it wants to offer its employees an opportunity to electively defer salary by adding a 401(k) feature to its plan. On that day, it adopts an amendment adding a 401(k) feature. Employee deferrals can begin no earlier than May 1, 2022, after employees execute deferral elections with respect to salary paid for services beginning on or after this date. Dromedary cannot allow salary deferrals to begin retroactively on January 1, 2022, because the CODA was not established until four months later. Example 5 Eagle is a sole proprietorship with no other employees. Eagle reports its income on Schedule C of the individual’s Form 1040. Eagle decides it wants to adopt a 401(k) plan in February 2024. Eagle’s owner can designate a portion of her 2023 self-employment income as an elective deferral because, under amendments to IRC section 401(b)(2) made by the SECURE 2.0 Act, a self-employed individual can make 2023 deferrals in 2024 as long as those deferrals are made before the due date of the employer’s 2023 tax return, without regard to any extensions. Issue indicators or audit tips Review the plan document and Form 5500 information to determine when it was made effective and adopted. Inspect the employer's tax return, noting its filing date and extensions. Reconcile plan contributions made in the examined plan year to the appropriate tax return of the employer. Examine plan contributions to ensure they were timely made, not later than the due date of the employer's tax return, including extensions. Review allocations made in the examination year to ensure they were timely credited to participants' accounts relative to the year they were tested as annual additions. Examine elective deferrals to verify they were made pursuant to a salary deferral election executed before deferrals were withheld (other than elective deferrals described in section 317 of the SECURE 2.0 Act). Compare deferral elections to plan document terms in place at the time the deferral election was executed. Review plan document terms and ensure they are being followed in operation. For example, if plan terms provide that a contribution will not be made beyond the due date of a return, a contribution beyond this time – although permissibly treated as an annual addition in the prior year – would not follow plan terms.
