Allocation Exceeds 415 Limit

[MarZDoates]

Employer has made contributions to a profit sharing plan in 2003 which caused three participants to exceed their 415 limit. I understand that we can either reallocate the excess among the other participants or hold in suspense to be allocated to three participants next year (2004). My question is: if we hold in a suspense account versus reallocating, can the employer still take a tax deduction on the excess for 2003? Or is it deductible in 2004. Will it be subject to excise tax? Based on the research I have done, it is not clear to me. Thanks for any and all input.

[Mike Preston]

What you do is controlled by the document, not a year by year choice.

The only amounts that are deductible are those that are allocated.

Amounts in excess of deductible limits are subject to excise tax.

[QDROphile]

You must first determine that the excess is eligible, which is not automatic even though most people seem to act that way. See Treas. Reg section 1.415-6(b)(6). Your plan document probably has similar terms about conditions for the excess to be eligible for the remedial options.

[mbozek]

Employer contributions are deductible in the tax year in which they are made or in the prior year if made by time for filing the income tax return. IRC 404(a)(6). The deduction is limited to 25% of covered comp but cannot not exceed the 415 limits. While contributions in excess of the 25% limit can be carried over to the next year and deducted for such year, contributions which exceed the 415 limits may not be carried over and deducted in a subsequent year. Notice 83-10, F-1, F-3.The deduction is made by claiming it on the tax return. Rev. Rul 76-28. The plan document determines how the excess contributions are to be applied.

What is not clear is whether contributions which do not in the aggregate exceed 25% of covered comp can be carried over to the next year and deducted under 25% limit on comp. to the extent excess contributions which exceed the 415 limit remain in the participant's account. Or even though the excess contributions are removed from the participant's account and transferred to the suspense account are the amounts still deemed to exceed the 415 limits in the year of contribution and thus not deductible in the subsequent year? You need to read the Notice 83-10 to find the answers to the above. Why not reallocate the excess contributions among the remaining participants for 2003?

[Mike Preston]

I think you are reading 83-10 F-1 wrong with respect to future years. Certainly, as I've already indicated, unless it is allocable is isn't deductible. That is backed up by F-1. So I agree with you on that point. However, the last sentence therein just means that the amount carried over isn't deductible in future years with respect to an allocation in a prior year. If the amount carried over is allocated in a future year (as if it is a current allocation in that future year) then it again becomes deductible in that future year.

It is meant to avoid non-discrimination "skirting". Take the example of a plan with 2 participants, each of which is entitled to 25% of pay in year 1, limited to the 415 limit. Participant 1 has $200,000 of comp, participant 2 has $50,000 of comp. The plan sponsor contributes 25% of total pay = $62,500. However, only $52,500 can be allocated without violating 415. The additional $10,000 is put in suspense. Only $52,500 is deductible with respect to the first year. To the extent there is an excise tax payable on that $10,000 it is paid.

The second year comes along and the compensations are the same, but the plan is amended to provide only for a contribution of 15% of pay. Now the allocations are $30,000 to participant 1 and $7,500 to participant 2. The total is $37,500 and is fully deductible.

What happens to the 415 carryover? In the absence of the last paragraph of F-1, the plan could allocate $40,000 to participant 1, keep the allocation of $7,500 to participant 2 and deduct the full $47,500.

That doesn't work pursuant to 83-10 as long as the carry-over is considered a contribution with respect to the prior year.

The above assumes that if $40,000 were allocated to participant 1 and $7,500 to participant 2 in year 2 the plan would fail non-discrimination.

Now change the facts a bit. Allocate the $10,000 carryover as a contribution in the second year. But now, for some reason, 401(a)(4) is not failed. In this case, you can allocate the combination of the carryover and the new monies in year 2 and take the full deduction in year 2, just as if you had contributed the right amount for year 1 and the right amount for year 2.

Unless the IRS has put something out that specifically addresses this fact pattern since 83-10 was published, that is what my notes say is the way it is supposed to be handled.

[MarZDoates]

Thanks, Mike. That's what I needed to know.