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.

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