Exceed 415 and 404 Limits

[Below Ground]

I have a 401(k) Plan that 2008 was the initial year. It has only one participant, the business owner, who makes well over $230K and is over age 50. During the year the client deposited $57,000. Since the IRC 415 Max is $51K (with the Catchup), there is $6,000 that exceeds both the deduction limit and the maximum individual allocation. I have two concerns that I do not have complete confidence with my conclusions.

First, I understand that under this Plan the Maximum Allocation under 415 is the Maximum Deductible, not 25%. If this is correct, the excess $6,000 is subject to the 10% excise penalty tax on nondeductible amounts. Am I missing something?

Second, the Plan allows a 415 excess to be corrected via a refund of employee contributions. Does this avoid the 10% penalty tax, and would that create a problem with the application of Catchup?

I am almost 100% sure on the Maximum Deductible Amount being the $51K. While less sure, I also believe the 10% excise tax will apply in all cases. I don't think a refund of employee contribution avoids the penalty tax as the Pension Answer Book says "...an excise tax imposed on the employer equal to 10 percent of the portion of any contribution..". I assume that "any" means any. If so, refunding the $6,000 would not avoid the penalty since the tax applies whether the contribution is employer or employee.

Any insights will be appreciated.

[K2retire]

The deduction limit is a plan limit of 25% of eligible comp -- in this case $57,500. However, the 415 limit, an individual limit, is indeed the lesser of 100% of compensation or $51,000.

The correction for a 415 violation in most documents is first to refund salary deferrals, then if necessary, forfeit employer contributions. The amount over $46,000 must still be considered to be catch up to stay within the 415 limit, even if the total deferrals are now less than $20,500.

[Bill Presson]

And since you're refunding deferrals because of a 415 violation, I don't think you have a deduction issue. Deferrals don't count against an employer's deductible limit anyway. So no 10% penalty.

[Below Ground]

Thanks both for your replies.

My biggest concern is whether the penalty tax truly is avoided. I see the logic that deferrals don't impact the employer's deduction. I guess my concern is that the deferrals being refunded would also not be deductible as a contribution under the plan. Maybe I am reading too much into this, but I still fear that the tax may apply.