Excess Contributions

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Contributions to a 401(k) plan must not cause the plan to violate the ADP nondiscrimination test. Contributions that cause the plan to fail the ADP test are referred to as excess contributions.

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Correction by Distribution

Excess contributions may be distributed to avoid plan disqualification (but no later than 12 months after the end of that plan year).

The final 401(k) regulations provide that any corrective distributions must include income allocable to the excess contributions, including income earned during the period from the close of the plan year for which the contribution was made until the corrective distribution is made. This income is called gap period income. The gap period income requirement was repealed for plan years beginning in or after 2008 by the PPA.

Impact on Participant

When an ADP test failure occurs, the excess contributions (and earnings) of HCEs may be distributed after the end of the plan year in which the failure occurs (but no later than 12 months after the end of that plan year). For plan years beginning on or after January 1, 2008, all distributions of excess contributions (and earnings) will be considered taxable income in the year in which the distributions are made. See Section 902(e) of the Pension Protection Act of 2006. (Under prior law, the distributions were income as of the date the deferrals were made if the distributions were made no more than 2 1/2 months after the close of the plan year.)

Excess contributions are annual additions under Code Section 415 even when distributed. Excess contributions that are distributed are not subject to the excise tax on early distributions, and are also not considered distributions for purposes of Required Minimum Distributions.

Impact on Employer

Excess contributions that are distributed more than 2 ½ months after the end of the plan year trigger a 10 percent excise tax for the employer on the corrective distribution. See Code Section 4979. An EACA, however, has six months to make distributions of excess contributions without paying the excise tax.

Form 1099-R

Beginning in 2009, report distributions of excess contributions on Form 1099-R as taxable distributions in the year in which the distributions are actually made.

Other Corrective Methods

Excess contributions can also be corrected by recharacterizing employee contributions as taxable employer contributions, by plan changes, or by a QNEC or QMAC.

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