IRS Freshens Discussion of Deductibility of Employer Contributions to a 401(k)

The IRS has updated the content it provides through an issue snapshot on the deductibility of employer contributions to a 401(k) plan made after the end of the tax year. The refresh accounts for application of the SECURE 2.0 Act. 

The Issue Snapshot discusses the timing rules of the Internal Revenue Code (IRC) and considers how those rules apply to employers that establish a new 401(k) plan after the end of the tax year.

Key changes include the following updated material. 

Timing of elective deferrals. In general, a qualified cash or deferred arrangement (CODA), an arrangement which allows eligible employees to make an election between receiving cash compensation or deferring compensation into the plan, can only be made regarding an amount that is not currently available to the employee on the date of the election. 

A CODA must be established before compensation can be deferred, and retroactive elective deferrals generally are not allowed. The IRS considers a plan to be established as of the later of: (1) the date the arrangement is adopted, or (2) the date the arrangement is effective.

However, Section 317 of SECURE 2.0 amended IRC section 401(b)(2) and provides an exception to this general timing rule for new single-member 401(k) plans. 
Effective with plan years beginning after the date of the enactment of the SECURE 2.0 Act—Dec. 29, 2022—an individual who owns the entire interest in an unincorporated business, and who is the only employee of such trade or business, can adopt a new 401(k) plan after the end of the taxable year. In addition, for the first year only, that individual can defer net earnings from self-employment in the prior year as late as the due date for his or her tax return.

Timing of allocations to participant accounts. Employer contributions are not treated as credited to a participant's account for a particular limitation year unless the contributions are actually paid to the plan no later than 30 days after the end of the IRC Section 404(a)(6) period (the extended due date of the employer's tax return). Contributions can be allocated to participants if paid within 30 days after the end of this period; however, they cannot be deducted unless they are paid before the end of that period. Contributions paid to the plan and allocated after the extended due date of the employer's tax return would be deductible in the following plan year, subject to the limitations of IRC Section 404(a)(3).