Five Ways to Lose Your Tax Exempt Status Part 4

Problems with Discrimination

The discrimination tests are vital to the maintenance of a tax exempt status. The common tests are ADP and ACP. ADP is concerned with employee pre-tax deferrals and ACP is concerned with employer matching contributions. When these tests fail, the options are to distribute excess amounts plus earnings to highly compensated employees or to make an additional contribution to non-highly compensated employees. This correction needs to be made within two and one-half months to avoid a 10% excise tax and the end of the next year to avoid plan disqualification. Remember, to ensure that the tests are calculated appropriately, communicate the plan’s definition of compensation with the party that performs the discrimination tests. Furthermore, discuss which tests need to be performed and which employees should be included in the tests. On a side note, the monies remitted back to highly compensated employees are taxable in the year distributed starting in 2009.

Please visit next week for part 5 of the series.