The timing of plan contributions and employer deductions may lead to surprising and troubling tax consequences.
As we approach the end of the calendar year (and yes, we really are getting close), employers may begin examining their obligations to make matching and profit-sharing contributions to those tax-qualified retirement plans that have a plan year ending December 31. They may also begin examining opportunities for taking deductions relating to their contribution obligations on their income tax returns.
Therefore, now is a good time for employers, particularly those with fiscal tax years that are not the calendar year, to focus on the rules governing timing of deductions for contributions made to the tax-qualified plans they sponsor.
Internal Revenue Service Code Section 404(a)(6) allows an employer to deduct contributions made to a tax-qualified retirement plan for an employer’s tax year during and after the end of that tax year, if the contributions are made by the due date of the employer’s tax return (or, if a proper application for extension is filed, by the deadline applicable to returns on extension), so long as the contribution is made “on account” of the employer’s tax year recently ended.
In order for a contribution to be made “on account” of the employer’s tax year, it must be related to work performed by employees in that tax year. Rev. Rul. 76-28, modified by Rev. Rul. 76-77. As an example, assume an employer’s fiscal year ends on June 30, 2018, but the employer makes contributions to a 401(k) whose plan year ends December 31, 2018. The only contributions that can be deducted on the employer’s income tax return for the fiscal year that ends June 30, 2018, would be those attributable to services rendered by employees from July 1 through December 31, 2017, and from January 1 through June 30, 2018. Contributions attributable to employee services rendered from July 1 through December 31, 2018, may not be deducted by the employer until the employer files its income tax return for the fiscal year ending June 30, 2019.
These rules apply to employers with cash and accrual basis accounting systems, and to deductions taken for employee elective deferral contributions and employer matching or profit-sharing contributions. Mistakes in the timing of deductions that result in an acceleration of deductions for contributions of the employer are “listed transactions” by the Internal Revenue Service under Treas. Reg. Sections 1.6011-4(b)(2) and 1.301.601-2(b)(2) in Rev. Rul. 90-105. Accelerated deductions must be disclosed to the IRS by the filing of an IRS Form 8886 (reportable transaction reporting statement) with the employer’s income tax return. The Form 8886 must be sent to the Office of Tax Shelter Analysis. Failure to file this required disclosure will result in the assessment of a penalty under Code Section 6707(a), which is 75 percent of the reduction of income tax resulting from the contribution deduction, up to $200,000.
The morphing of the simple act of making a contribution to a 401(k) plan into a transaction that has to be disclosed as a “tax shelter” is not something employers are likely to anticipate. Due diligence in this area at the end of the calendar year may prevent a nasty surprise.