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|7) Elective deferrals weren't limited to the amounts under IRC Section 402(g) for the calendar year and excess deferrals weren't distributed.||Inspect deferral amounts for plan participants to ensure that the employee hasn't exceeded the limits.||Distribute excess deferrals.||Work with plan administrators to ensure that they have sufficient payroll information to verify the deferral limitations of IRC Section 402(g) were satisfied.|
Internal Revenue Code Section 402(g) limits the amount of elective deferrals a plan participant may exclude from taxable income each calendar year. IRC Section 401(a)(30) provides that, for a plan to be qualified, it must provide that the amount of elective deferrals for each participant under all plans of the same employer not exceed the 402(g) limits. The limit on elective deferrals under Section 402(g) is:
- $19,000 in 2019 ($18,500 in 2018)
- This limit is subject to cost-of-living increases for later years (for prior years, refer to the cost-of–living adjustment table.)
Limits on the amount of elective deferrals a plan participant may contribute to a SIMPLE 401(k) plan are different than those in a traditional or safe harbor 401(k) plan.
- SIMPLE 401(k) deferrals are limited to $13,000 in 2019 ($12,500 in 2018).
- This limit is subject to cost-of-living increases in later years.
Catch-up contributions: A plan may permit participants age 50 or over at the end of the calendar year to make additional deferrals. These additional contributions are called catch-up contributions and these aren't subject to the general limits that apply to 401(k) plans (see IRC Section 414(v)). An employer isn't required to provide for catch-up contributions. However, if your plan allows catch-up contributions, you must allow all eligible participants to make catch-up contributions.
- If an employee participates in a traditional or safe harbor 401(k) plan and is age 50 or older, the elective deferral limit increases by $6,000 in 2019 and 2018.
- If an employee participates in a SIMPLE 401(k) plan and is age 50 or older, the elective deferral limit increases by $3,000 in 2019 and 2018.
- These limits are subject to cost-of-living increases in later years.
- The catch-up contribution for a year can't exceed the lesser of:
- The catch-up contribution limit, or
- The excess of the employee’s compensation over the elective deferrals that aren't catch-up contributions.
Catch-up contributions are not subject to the Section 401(a)(30) plan qualification rule.
Elective deferrals include both pre-tax deferrals and designated Roth contributions. Generally, you must consider all elective deferrals made by a participant to all plans in which the employee participates to determine if the employee has exceeded the 402(g) limits. If an employee has elective deferrals in excess of the 402(g) limit under one or more plans of an employer, each plan is subject to disqualification.
Your plan document may impose its own lower limit on the deferral amount or on the percentage of pay that participants may defer. Additionally, your plan may need to limit a plan participant’s elective deferrals to meet certain nondiscrimination requirements.
If the total of a plan participant’s elective deferrals exceeds the limit under IRC Section 402(g), to avoid failing IRC Section 401(a)(30), the excess amount plus allocable earnings must be distributed to the participant by April 15 of the year following the year of deferral. Excess deferrals not timely returned to the participant are subject to additional tax.
Timely withdrawal of excess contributions by April 15
- Excess deferrals withdrawn by April 15 of the year following the year of deferral are taxable in the calendar year deferred.
- Earnings are taxable in the year they're distributed.
- There is no 10% early distribution tax, no 20% withholding and no spousal consent requirement on amounts timely distributed.
Consequences of a late distribution
- Under IRC Section 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS.
- Under EPCRS, these excess deferrals are still subject to double taxation; that is, they're taxed both in the year contributed to and in the year distributed from the plan.
- For any distributions, attributable to elective deferrals designated as Roth Contributions, all distributions will be reported as taxable in the year distributed. Designated Roth contributions will have already been included in income in the year of deferral.
- These late distributions could also be subject to the 10% early distribution tax, 20% withholding and spousal consent requirements.
Excess deferrals distributed to highly compensated employees are included in the Actual Deferral Percentage (ADP) test in the year the amounts were deferred. Excess deferrals distributed to nonhighly compensated employees aren't included in the ADP test if all deferrals were made with one employer. Excess deferrals distributed after April 15 are included in annual additions for the year deferred.
How to find the mistake:
Ensure that no one's elective deferrals exceed the 402(g) limit for a year by comparing the amount deferred to the 402(g) limit. If anyone exceeds the 402(g) limit and this isn't corrected, the plan could be disqualified.
How to fix the mistake:
IRC Section 72(t) imposes a 10% additional tax for distributions that don't meet an exception, such as death, disability or attainment of age 59 ½, among others. To avoid this additional tax, correct excess deferrals no later than April 15 of the following year. If you don't correct by April 15, you may still correct this mistake under EPCRS; however, it won’t relieve any Section 72(t) tax resulting from the mistake.
Under Revenue Procedure 2016-51, Appendix A, section .04, the permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable both in the year of deferral and in the year distributed. These amounts are reported on Forms 1099-R. These amounts are reported on Forms 1099-R. In the case of amounts designated as Roth contributions, the excess deferral will already have been reported in income in the year of deferral. However, the amount will be reported as taxable in the year distributed.
Employer X maintains a 401(k) plan that has 21 participants and plan assets of $715,000. For calendar year 2018, Ann deferred $18,500 to the plan. None of the elective deferrals were designated as Roth contributions. Ann is under age 50 and isn't eligible to make catch-up contributions. Ann has excess deferrals of $500 because $18,000 is the 402(g) maximum amount permitted for 2018. Employer X didn't discover this mistake until after April 15, 2019. On November 1, 2019, X distributed the excess deferral (plus earnings of $10, totaling $510) to Ann.
For 2018 (year of deferral), Ann must include $500 in gross income. For 2019 (year of distribution), Ann must include $510 in gross income. Employer X would report this amount on Form 1099-R. In addition, Ann must pay the additional 10% early distribution tax under IRC Section 72(t).
Correction programs available:
The example shows an operational problem because Employer X failed to follow the plan terms prohibiting any employee’s elective deferrals from exceeding the 401(a)(30) limit. If the other eligibility requirements of SCP are satisfied, Employer X may use SCP to correct the failure.
- No IRS imposed user fees for self-correction.
- Practices and procedures must be in place.
- If the mistakes are significant in the aggregate:
- Employer X needs to make a corrective distribution by December 31, 2016.
- If not corrected by December 31, 2016, Employer X isn't eligible for SCP and must correct under VCP.
- If the mistakes are insignificant in the aggregate, Employer X can correct beyond the two-year correction period for significant errors. Whether a mistake is insignificant depends on all facts and circumstances.
Voluntary Correction Program:
Correction is the same as under SCP. If the plan is not under audit, Employer X makes a VCP submission per Revenue Procedure 2016-51. When making the submission, Employer X must include Forms 8950 and 8951 and consider using the model documents set forth in the Form 14568 series. Based on the amount of plan assets , $715,000, Employer X would pay a user fee of $3,000 for a submission made in 2019. VCP user fees may change in subsequent years.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as under SCP or VCP. Employer D and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction. The sanction under Audit CAP is based on facts and circumstances, as discussed in Section 14 of Revenue Procedure 2016-51.
How to avoid the mistake:
- Work with your plan administrator to ensure that the administrator has sufficient payroll information to verify that the deferral limitations of IRC Section 402(g) were satisfied.
- Establish procedures to ensure that, based on the participant election forms (including modifications), participants won’t exceed the IRC Section 402(g) limit.
- Have checks and balances in place to alert you and your plan administrator when the limit is exceeded to take timely corrective action.