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Treatment of Excess Deferrals: Retirement Plans for Business Owners (2025 IRS Guide)

This guide covers “Treatment of Excess Deferrals” within retirement plans for business owners. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 560 (2025), Retirement Plans for Small Business, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

Your qualified plan can include a cash or deferred arrangement under which participants can choose to have you contribute part of their before-tax compensation to the plan rather than receive the compensation in cash. A plan with this type of arrangement is popularly known as a 401(k) plan. (As a self-employed individual participating in the plan, you can contribute part of your before-tax net earnings from the business.) This contribution is called an elective deferral because participants choose (elect) to defer receipt of the money.

In general, a qualified plan can include a cash or deferred arrangement only if the qualified plan is one of the following plans.

  • A profit-sharing plan.

  • A money purchase pension plan in existence on June 27, 1974, that included a salary reduction arrangement on that date.

Treatment of Excess Deferrals

If the total of an employee's deferrals is more than the limit for 2025, the employee can have the difference (called an excess deferral) paid out of any of the plans that permit these distributions. The employee must notify the plan by April 15, 2026 (or an earlier date specified in the plan), of the amount to be paid from each plan. The plan must then pay the employee that amount, plus earnings on the amount through the end of 2025, by April 15, 2026.

Excess withdrawn by April 15.

If the employee takes out the excess deferral by April 15, 2026, it isn't reported again by including it in the employee's gross income for 2026. However, any income earned in 2025 on the excess deferral taken out is taxable in the tax year in which it is taken out. The distribution isn't subject to the additional 10% tax on early distributions.

If the employee takes out part of the excess deferral and the income on it, the distribution is treated as made proportionately from the excess deferral and the income.

Even if the employee takes out the excess deferral by April 15, the amount will be considered for purposes of nondiscrimination testing requirements of the plan, unless the distributed amount is for a non-highly compensated employee who participates in only one employer's 401(k) plan or plans.

Excess not withdrawn by April 15.

If the employee doesn't take out the excess deferral by April 15, 2026, the excess, though taxable in 2025, isn't included in the employee's cost basis in figuring the taxable amount of any eventual distributions under the plan. In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Also, if the employee's excess deferral is allowed to stay in the plan and the employee participates in no other employer's plan, the plan can be disqualified.

Reporting corrective distributions on Form 1099-R.

Report corrective distributions of excess deferrals (including any earnings) on Form 1099-R. For specific information about reporting corrective distributions, see the Instructions for Forms 1099-R and 5498.

Tax on excess contributions of highly compensated employees.

The law provides tests to detect discrimination in a plan. If tests, such as the ADP test (see section 401(k)(3)) and the ACP test (see section 401(m)(2)), show that contributions for highly compensated employees are more than the test limits for these contributions, the employer may have to pay a 10% excise tax. Report the tax on Form 5330. The ADP test doesn't apply to a safe harbor 401(k) plan (discussed next) or to a QACA. Also, the ACP test doesn't apply to these plans if certain additional requirements are met.

The tax for the year is 10% of the excess contributions for the plan year ending in your tax year. Excess contributions are elective deferrals, employee contributions, or employer matching or nonelective contributions that are more than the amount permitted under the ADP test or the ACP test.

See Regulations sections 1.401(k)-2 and 1.401(m)-2 for further guidance relating to the nondiscrimination rules under sections 401(k) and 401(m) respectively.

Caution:

If the plan fails the ADP or ACP testing, and the failure isn't corrected by the end of the next plan year, the plan can be disqualified.

Safe Harbor 401(k) Plan

If you meet the requirements for a safe harbor 401(k) plan, you don't have to satisfy the ADP test or the ACP test if certain additional requirements are met. For your plan to be a safe harbor plan, you must meet the following conditions.

  1. Matching or nonelective contributions. You must make matching or nonelective contributions according to one of the following formulas.

    1. Matching contributions. You must make matching contributions according to the following rules.

      1. You must contribute an amount equal to 100% of each non-highly compensated employee's elective deferrals, up to 3% of compensation.

      2. You must contribute an amount equal to 50% of each non-highly compensated employee's elective deferrals, from 3% up to 5% of compensation.

      3. The rate of matching contributions for highly compensated employees, including yourself, must not exceed the rates for non-highly compensated employees.

    2. Nonelective contributions. You must make nonelective contributions, without regard to whether the employee made elective deferrals, on behalf of all non-highly compensated employees eligible to participate in the plan, equal to at least 3% of the employee's compensation.

    These mandatory matching and nonelective contributions must be immediately 100% vested and are subject to special withdrawal restrictions.

  2. Notice requirement. You must give eligible employees written notice of their rights and obligations with regard to contributions under the plan within a reasonable period before the plan year.

If you make nonelective contributions and you either don't make any matching contributions or you make matching contributions that are intended to satisfy the ACP test, then this notice requirement doesn’t apply. However, this exception doesn’t apply to the EACA notice requirement, discussed earlier.

The other requirements for a 401(k) plan, including withdrawal and vesting rules, must also be met for your plan to qualify as a safe harbor 401(k) plan.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.

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