Small Business 401k Plans and the IRS

By | February 18, 2015

A 401(k) plan is really a profit-sharing plan with a cash or deferred feature that’s added to it. These 401(k) plans are going to have the same eligibility requirements as that profit-sharing plan. Generally, a plan may exclude employees working less than 1,000 hours in any year or who are under age 21. Employees can choose to have a portion of their salary deposited to their individual account.


401k Plan Rules

They don’t pay tax on that salary deferred into the plan, but those amounts are subject to payroll taxes. The money in the account is not taxed until it’s withdrawn. And employee salary deferrals are limited to no more than $17,500 for 2014, plus an additional $5,500 if the employee is age 50 or over by the end of that calendar year.


Employer 401k Contributions

Employers may choose to make matching or other employer contributions to the plan. The total annual additions to the plan – that’s the total of all employee, employer and any forfeitures that might have accumulated in the plan – those cannot exceed the lesser of 100 percent of compensation or $52,000 for 2014; $57,500 if you include the catch-up contributions.


Employers must conduct annual nondiscrimination testing

Employers must conduct annual nondiscrimination testing in traditional 401(k) plans. Salary deferrals are tested with the Actual Deferral Percentage, or ADP test, and matching and other contributions are tested under the Actual Contribution Percentage, or ACP test. The ADP test compares the average deferral percentages for the non-highly-compensated group with the average deferral percentages for the highly-compensated employee group. This works to limit the contributions for highlycompensated employees.


What is a highly-compensated employee in 401k plan?

For example, if the ADP for the non-highly-compensated employees is four percent, in order to pass this test, the ADP for the highly-compensated employees could not exceed six percent. It is extremely easy to fail this test. If an employee is left off the test, they are normally one that was eligible to participate in the plan, but chose not to defer any salary into the plan. That would be adding a zero into the test, and then, most likely, you would not be passing the test. You’ll then need to make correction by making additional contributions to the non-highly-compensated group or taking money from the highly-compensated group.


ADP/ACP testing

With a traditional 401(k) plan, you have to run the ADP and ACP test every year, and the contributions available to the highly compensated employees can be limited. But there are ways to avoid the ADP/ACP testing and raise the amount highlycompensated employees can defer. The first one is to choose a safe harbor 401(k) plan, which allows an employer to avoid nondiscrimination testing in exchange for providing a certain level of contributions for employees.

The employer sponsoring a safe harbor 401(k) plan must choose either a minimum matching contribution or a flat percentage of salary for all participants. If they choose the matching contribution option, they must match 100 percent of the first three percent of salary plus 50 percent for the next two percent of elective deferrals, a maximum total of four percent. Or they can choose to make a non-elective contribution of three percent of compensation for all participants, including those who choose not to make any elective deferrals.


401k Filing Requirement

The 401(k) plans have a filing requirement. They must file an annual Form 5500-series return with the IRS or DOL. Now, which Form 5500 that’s required generally will depend on the number of participants covered in the plan. The 401(k) plans must file either a Form 5500, a Form 5500-SF, or if it’s a one-participant plan, a Form 5500-EZ.