Nondeductible contribution

[perplexedbypensions]

Hello.

In 2018 a client projected profits to be higher than they were, and in 2018 they deposited an amount above their allowable contribution amount for 2018.

Can someone point me in the direction of the correction for this?

Thank you!!

[ESOP Guy]

The correction is pay the excise tax and stop making contributions to the plan until the excess is worked off.

The other thing they should obviously do is stop prepaying the contribution so close to their estimated maximum.  Putting some in can be fine but large amounts of pre-paid contributions end this way too often.  

But if you are looking for a way to get the money out of the plan and not paying the excise tax it isn't going to happen.   Sorry, I know it isn't the answer people want to hear but it is the correct answer. 

 

[ESOP Guy]

If you aren't familiar with the excise tax here is the instructions for the form used to file and pay the taxes. 

https://www.irs.gov/pub/irs-pdf/i5330.pdf

[perplexedbypensions]

Thank you ESOP Guy.

So there will be a 10% excise tax on the excess.  Do the funds have to remain in the plan, or can they be returned to the employer?   

[ESOP Guy]

The excess funds stay in the plan.   They can deduct those excess amounts in future years which reduces the amount of the excise tax in future years.

Example (kind of an extreme example in fact):

Total payroll for deduction purposes is 1,000,000/year.

So max deduction is $250,000/year (25% of the compensation for the limit)

They deposited $600,000 in 2018 for 2018

Excess for 2018 is $350,000  (600,00 - 250,000)

Excise tax is $35,000

In 2019 the excess is $100,000 which is the $350,000 excess - the $250,000 they can deduct in 2019. 

so the excise tax for 2019 is $10,000

As long as they don't deposit more than $150,000 in 2020 there would be no more excise taxes due. 

Hopefully, the excess amount isn't actually so large it creates a multi-year excise tax but it can do so if bad enough.    

I believe the IRS publication I linked to give these details also.  

[perplexedbypensions]

Luckily, the excess is not large.

Does the amount of the excess need to be allocated for the 2018 PY, so that the total amount that was contributed gets allocated (as long as no one goes over 415 limit)?  

Or is the allocation for 2018 the deductible amount, and then the excess is allocated in the next PY?

I think I have read that it is allocated in the year it is contributed, but want to confirm.

Thank you for the help!!!

[ESOP Guy]

It is all allocated in the year contributed.  This is all about the deduction and excise tax only.  

[justanotheradmin]

This is older, but I still find it helpful, and the language easier to understand with some of the examples for deduction issues. 

https://www.irs.gov/pub/irs-tege/epche903.pdf