Contributions to the plan are known as annual additions and are limited under section 415. Annual additions include employer contributions, employee contributions, and forfeiture reallocations. Section 415 limits the annual additions a participant may receive in a limitation year to the lesser of 100% of section 415 compensation or $72,000 (as indexed for 2026). The limitation year is defined in your adoption agreement and generally, coincides with the plan year. The 415 limit testing reviews each participant’s annual additions for potential excesses.

The ADP and ACP tests are nondiscrimination tests which compare the contributions of the highly compensated employees (HCEs) to the nonhighly compensated employees (NHCEs) for the plan year. The elective deferral contributions for the plan year are tested in the ADP test (Actual Deferral Percentage test). The employer matching contributions are tested in the ACP test (Actual Contribution Percentage test). The group average of the individual percentages of the NHCEs sets the passing limit for group average of the individual percentages of the HCEs. If the ADP test or the ACP test fail, correction can be refunding contributions to the HCEs or making contributions to the NHCEs.

An employee is considered an HCE due to either ownership or compensation. An employee who earned in excess of $160,000 (as indexed by the IRS) in the prior plan year is considered to be an HCE. An employee who is a more than 5% owner in the current or prior plan year is considered to be an HCE. Due to family attribution rules, the spouse, children, parents, and grandparents of a more than 5% owner are attributed with ownership and are considered to be HCEs.

Since the company was not in existence in the lookback year, none of the employees would have any compensation in the lookback year. No one would be considered an HCE based on the compensation test. There may be HCEs due to the ownership test in the year the company starts up.

If the spouse was married to the owner at any time during the plan year, the spouse would be attributed with ownership under the attribution rules of Code Section 318 for that plan year. Since the spouse is a more than 5% owner in the current plan year or in the lookback year under attribution rules, he or she would be considered an HCE.

A plan can limit the number of employees to be considered an HCE by making a top paid group election. The top paid group election states that if more than 20% of the employees earn over $160,000 (as indexed for 2026), only the top paid 20% will be considered highly compensated under the compensation test. The top paid group election is made through a plan amendment, and the election would remain in place until removed through a plan amendment.

In any year if an owner has no earned compensation, he or she would not be considered to be an employee and would not be included in the ADP and ACP tests.

After-tax contributions are subject to nondiscrimination testing.

If the failed ADP and ACP Tests are corrected after the 2 ½ month deadline by making corrective distributions, the employer incur an excise tax of 10% of the amount of the excess contribution. No penalty applies if the tests are corrected by making a qualified non-elective contribution.

Excess contributions arise when the ADP test fails. If excess contributions plus earnings are distributed within 2 ½ months following the close of the plan year, the HCE reports certain amounts in gross income in the taxable year in which the first elective contributions of that plan were made. If the excess is distributed after 2 ½ months following the close of the plan year, but within 12 months after the close of the plan year, the entire amount is taxable in the calendar year distributed.

The 1099-R for corrective distributions is issued the January following the end of the calendar year the corrective distribution was processed.