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Issue Snapshot - Treatment of 415(c) Dollar Limitations in a Short Limitation Year

This Snapshot discusses how to adjust the IRC Section 415(c) defined contribution dollar limitation for a short limitation year, resulting from, for example, an initial, amended or terminating plan year.

IRC Sections and Treasury Regulations

  • IRC Section 401(a)(16)
  • IRC Section 415(c)
  • Treas. Reg. Section 1.415(c)-1
  • Treas. Reg. Section 1.415(j)-1

Resources

Analysis

Total annual additions to a participant’s defined contribution plan account are limited to the dollar amount imposed by IRC Section 415(c). Annual cost-of-living adjustments apply to this dollar limit. If the participant’s compensation is less than the dollar limit, annual additions during a limitation year must not exceed 100% of compensation.

The limit applies to the total of:

  • elective deferrals (but not catch-up contributions within the meaning of IRC Section 414(v)),
  • employee contributions,
  • employer matching and nonelective contributions, (but not restorative payments under Section 1.415(c)-1(b)(2)(ii)(C)), and
  • allocations of forfeitures. See generally IRC Section 401(a)(16) and 415(c) and Treas. Reg. Section 1.415(c)-1.

For 2018, the dollar limit on annual additions to a participant’s accounts for all defined contribution plans maintained by an employer is $55,000. See COLA Increases for Dollar Limitations on Benefits and Contributions for other years.

Short limitation years

Although most plans maintain limitation years concurrent with the plan year, a plan may be amended to change the limitation year to a different 12-month period beginning with any day within the current limitation year. This creates a short limitation year which begins on the first day of the current limitation year and ends on the day before the first day of the new limitation year. Treas. Reg. Section 1.415(j)-1(d)(2).

A terminating defined contribution plan is treated as having amended its limitation year if the effective date of the termination is any date other than the last day of the plan’s limitation year. The short limitation year ends on the effective date of the plan termination. Treas. Reg. Section 1.415(j)-1(d)(3).

It’s possible for a new plan to have an initial limitation year of less than 12 months, depending on how the plan is drafted. However, a new plan adopted after the beginning of the new limitation year will not have a short limitation year if the effective date is retroactive to the first day of the 12-month limitation year (though elective deferrals cannot begin before the adoption date).

Proration of the IRC Section 415(c) limit

The contribution limit for a short limitation year is determined by multiplying the applicable dollar limit for the calendar year in which the short limitation year ends by a fraction, the numerator of which is the number of months (including any fractional parts of a month) in the short limitation year, and the denominator of which is 12.

Example 1 - amendment

Plan A is a profit-sharing plan with a calendar limitation year. On June 30, 2018, the plan is amended to change the limitation year to a fiscal year ending June 30. The amendment creates a short limitation period from January 1 to June 30, 2018 (6 months). Because the short limitation year ends in 2018, the prorated short limitation year is calculated based on the 2018 limit of $55,000.

The prorated short year IRC Section 415(c) limit is: $55,000 x (6/12) = $27,500.

Example 2 – termination

Plan B is a profit-sharing plan with a calendar limitation year. The plan is terminated effective September 15, 2018. The plan termination is treated as if an amendment has been adopted to change the limitation year to a year beginning September 16, 2018. A short limitation year is created from January 1 to September 15, 2018 (8.5 months). Because the plan terminated in 2018, the prorated short year limitation is calculated based on the 2018 limit of $55,000 under IRC Section 415(c).

The prorated short year IRC Section 415(c) limit is: $55,000 x (8.5/12) = $38,958.

Note in both of these examples, in a short limitation year, the IRC Section 415(c) dollar limitation is prorated to reflect a lesser maximum amount of contributions that can be contributed.

Participants eligible for part of limitation year

Limits on annual additions and compensation are not prorated for employees who are eligible to participate in the plan for only part of the limitation year (for example, participants entering the plan in July of a calendar limitation year). Proration of these limits only applies when the limitation year is less than 12 months. Plan provisions can limit compensation taken into account to the period of participation. For example, a plan’s administrable definition of compensation can be defined to provide that compensation for purposes of applying the allocable share of profit sharing contributions only applies to that portion of a plan year during which an employee is an eligible participant.

Example 3

Plan C is a profit-sharing plan with a calendar limitation year. Susan becomes a participant in the plan on July 1, 2018. The IRC Section 415(c) dollar limit is not reduced for Susan even though she is a participant in the plan for only 6 months. Alternatively, it would be prorated to 50% of the IRC Section 415(c) dollar limit if the plan is amended to create a short limitation year that begins on July 1, 2018 and ends on December 31, 2018.

Plan Termination

One of the more common required prorations of a plan’s limitation year occurs when a plan terminates. As noted above, most plans are administered with concurrent plan / limitation years. Termination of such a plan before its last day will lower the dollar limit on the maximum amount of annual additions that may be credited to a participants account in its final year. Treas. Reg. Section 1.415(j)-1(d)(3) requires that when a defined contribution plan is terminated effective as of any date other than the last day of its limitation year, the plan is treated as if it has been amended to change the limitation year to a period ending on the date of termination. This requires proration of the IRC Section 415(c) dollar limitation for the termination year, and might restrict the maximum amount otherwise allocable to a participant.

Audit tips

  1. Identify the limitation year used by a defined contribution plan maintained by the employer. Has the year changed?
    • Is there amendment that reflects the change?
    • If not, is it required (for example, not required in the case of a plan termination that creates a short limitation year)?
  2. If the limitation year has been changed and a short limitation period is created, has a prorated section 415(c)(1)(A) dollar limitation been used for the short limitation year? For the section 415(c)(1)(B) compensation limit, has compensation earned only during the short limitation year been used to establish the maximum amount?
  3. If the plan was terminated, other than at the end of a limitation year, did the plan use a prorated dollar limitation to determine maximum annual additions to the plan?