Nondiscrimination testing failures are a common headache for 401(k) plan sponsors, particularly for plans without a safe harbor design. When a plan fails the Actual Deferral Percentage (ADP) or Actual Contribution Percentage (ACP) test, a 10% excise tax under IRC § 4979 may be owed — reported on Form 5330.
What Triggers the § 4979 Excise Tax?
The excise tax applies when excess contributions or excess aggregate contributions are not timely corrected. Specifically:
- ADP test failure (§ 401(k)): Excess contributions (HCE deferrals exceeding the ADP limit) must be distributed or recharacterized by the 2.5-month deadline (March 15 for calendar-year plans) to avoid both income tax and the § 4979 excise tax.
- ACP test failure (§ 401(m)): Excess aggregate contributions (HCE matching contributions exceeding the ACP limit) must be distributed by the same 2.5-month deadline.
The 10% Excise Tax Rate
The excise tax is 10% of the excess contributions or excess aggregate contributions that were not timely corrected. This is assessed on the plan sponsor (employer), not on the participants.
Due Date for § 4979 Returns
The Form 5330 for § 4979 is due by the last day of the 15th month after the close of the plan year. For a calendar-year plan, that is March 15 of the year following the plan year. This is notably different from § 4975 (7-month rule) and § 4972 (7-month rule).
What If Correction Happened After the 2.5-Month Deadline?
If excess contributions were distributed after the 2.5-month deadline but before the 15th-month deadline, the § 4979 excise tax is still owed for the period of the failure, and must be reported on Form 5330. The amount of the excess at the time of the plan year end drives the calculation.
Schedule H of Form 5330
§ 4979 excise taxes are reported on Schedule H of Form 5330. Line 1 captures the total excess contributions. The 10% tax is computed there and flows to Part I, Line 1b of the main form.
Prevention: Safe Harbor Designs
The most effective way to avoid § 4979 is to adopt a safe harbor 401(k) plan design, which eliminates ADP/ACP testing requirements in exchange for mandatory employer contributions. This is worth discussing with your plan's ERPA or benefits counsel.