I Missed March 15th. Now What? by Joseph M. Burt
I think it’s fair to say that most of us consider ourselves overachievers and don’t like being told we failed at something. We’ve been taught our whole lives to pass any test we encounter, so when we are told we didn’t, the feeling of having done something wrong and the concern of being “in trouble” triggers our emotional senses. However, when it comes to passing the nondiscrimination tests associated with your retirement plan, you should never encounter a “fight or flight” reaction.
What Do I Need to Do Before March 15th?
For calendar year 401(k) plans subject to the results of the “Actual Deferral Percentage” (ADP) and “Actual Contribution Percentage” (ACP) tests, March 15th is the deadline to refund any excess contributions to the Highly Compensated Employees (HCE) if you want to avoid any excise taxes. (Two and a half months after the plan year end is the deadline for non-calendar year plans.) Many Plan Sponsors and HCEs consider these excess contributions and their refund to be a failure that should have been avoided. It’s important to remember, even if a refund is ultimately made, the HCE was able to defer the maximum amount possible under the testing rules in the previous year and realize any allowable deductions. See, it’s not so bad!
In addition to that good news, the affected participants will be taxed on the excess amounts in the year they receive the refund (thereby delaying the tax on that amount for a tax year), and the amount the participant receives will be adjusted for earnings or losses. Although the refund is not eligible to be rolled over into any other type of plan or IRA, it is not subject to an early withdrawal penalty.
It’s All About the Refund!
The consequence of not completing the refunds by the deadline outlined above is that the employer is required to pay an excise tax to the Internal Revenue Service. This tax is equal to 10% of the amount that should have been refunded by the deadline, not including earnings or losses. If the plan qualifies as an Eligible Automatic Contribution Arrangement (EACA), the plan’s testing period is extended from 2 ½ months to 6 months after the plan’s year-end (June 30 for calendar year plans).
Your Third-Party Administrator (TPA) will be instrumental in helping you make these corrections by first calculating the proper amount of the excise tax and completing a signature-ready Form 5330 required to pay the tax. It’s important the filing be completed no later than the 15th month following the end of the plan year during which the testing failure occurred to avoid additional penalties and potential plan disqualification.
Common Reasons the Deadline is Missed
There are many reasons why an employer could miss this deadline. Here are just a few:
- Payroll information was not available to have the plan’s testing completed timely
- For certain companies, a Schedule K-1 or Schedule C is needed to test the plan and the Schedules were not completed by March 15th
- Errors in compensation or 401(k) and/or matching amounts caused the test failure to be discovered after the deadline
- (Admit it; we are all guilty of waiting until the last minute to act at one time or another.) If we wait too long, it’s possible the refunds won’t be processed in time.
If you missed the March 15th deadline, don’t wait to take corrective action. As stated above, the excise tax is due on the last day of the fifteenth month after the close of the plan year. However, don’t confuse this tax deadline with the due date for removing the excess amounts from the participant’s accounts. The excess contribution must be refunded by the last day of the Plan year following the year of failure (e.g., if the plan failed 2018 ADP/ACP testing, the excess must be refunded by 12/31/2019). If the refund is not completed by this date, the excess contribution, including earnings, must still be refunded and a mandatory employer contribution (often referred to as a qualified nonelective contribution or “QNEC”) equal to the amount of the excess contribution including earnings must be contributed to the plan on behalf of the non-highly compensated employees.
Your TPA is a tremendous resource in helping navigate these challenges. Make certain to reach out to them for guidance as soon as a problem has been identified or anytime you have questions about your plan. They are experts in providing ideas, concepts, and solutions to correct and prevent potential testing issues and enhance your plan in ways that ensure a successful outcome for both the Plan and its participants.
Author is Joseph M. Burt, ERPA, APA, APR, QPA, QKA, the Immediate Past President of NIPA and owner of Pension Plan Specialists, PC, a TPA firm in Vancouver, Washington.