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Excess Solo 401k contributions

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When the Solo 401k participant contributes more than the allowable deduction for a given tax year, they are typically required to pay a 10 percent penalty on the over contribution amount (also known as the excess nondeductible contribution amount pursuant to (IRC Sec. 4972)).

Determine contribution type

When removing excess contributions from the plan, the Solo 401k participant must first determine the type of contribution being removed.

There are two types of contributions that apply to a Solo 401k:

  • Employee elective deferral contributions
  • Employer profit sharing contributions

The rules are different for each contribution type

The rules for removing the employee contributions vs. the employer profit sharing contributions are different.

For excess employee salary deferral contributions

  • If the excess employee salary deferral contribution is not returned on or before April 15 of the following year, the Solo 401k participant must pay income tax on the deferral both in the year of deferral and in the year of distribution.
  • The deferrals are not included as after-tax assets even though they have previously been included in income in the year of deferral (IRC Sec. 402(g)(1) and (Treas. Reg. 1.402(g)-1(e)(8))
  • The earnings on the excess will be taxed in the year of distribution
  • Any corrective distribution of less than the entire amount of the excess deferral plus income is treated as a pro rata distribution of excess deferrals and income (IRC Sec. 402(g)(2)(D), Treas. Reg.1.402(g)-1(e)(10))

For excess employer profit sharing contributions

  • They will need to remain in the Solo 40k plan and treated as contributions in future years. However, a 10% penalty will need to be paid on the over contribution amount also known as the excess nondeductible contribution amount pursuant to IRC Sec. 4972.
  • This penalty amount of 10% will need to be reported by the Solo 401k owner by filing IRS Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, and remitting the penalty to the IRS
  • Please refer to IRC Sec. 404(a)(1)(E) as it details that the amount of the otherwise deductible contribution that exceeds the limitation for any given year shall be carried forward indefinitely and applied to subsequent years
  • Although excess nondeductible Solo 401k contributions may be returned to the Solo 401k employer/adopting business under limited circumstances, the Solo 401k employer runs the risk of incurring substantially greater penalties by taking a reversion of plan contributions. The reversion penalty is typically as high as 50 percent depending on the circumstances pursuant to (IRC Sec. 4980).

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