Discrimination Tests for Qualified Retirement Plans

Contributions or benefits under the plan must not discriminate in favor of highly compensated employees under a qualified plan.

For example, you cannot allow highly compensated employees to have a higher contribution rate than other employees.

Highly compensated employees:

A highly compensated an individual who:

  • Owned more than 5% of the interest in your business at any time during the year or the preceding year, regardless of how much compensation that person earned or received, or
  • For the preceding year, received compensation from you of more than $115,000 (if the preceding year is 2012, ($110,000 if the preceding year is 2011 or 2010) and, if you so choose, was in the top 20% of employees when ranked by compensation.

The law provides tests to detect discrimination in a plan such as:

  • Actual deferral percentage test (ADP test) (IRC section 401(k)(3)).
  • Actual contributions percentage test (ACP test) (IRC section (401(m)(2))

The ADP and ACP tests do not apply to safe harbor 401((k) plans.

Excise tax penalty on excess contributions:

If these show that contributions for highly compensated employees are more than the test limits for these contributions, the employer may have to pay a 10% excise tax. The tax is reported on Form 5330.

The tax for the year is 10% of the excess contributions for the plan year ending in your tax year.

Excess contributions are:

  • Elective deferrals, employee contributions, or employer matching or nonelective contributions that are more than the amount permitted under the ADP test or the ACP test.

File your personal and small business taxes (Schedule C)