Accounting Treatment of Refund of Excess Contributions

Posted by Chris Ciminera, CPA, QKA

Disclaimer: All blog posts are valid as of the date published.

Refund of Excess Contributions - Delaware 401k Audit There is a popular philosophical question that asks if a tree falls in a forest, and no one is around to hear it, does it make a sound? My opinion is that it does make a sound. However, I want to stay away from a philosophical debate about trees and instead ponder whether retirement plan contributions that end up exceeding legislative limits for the plan year can still be considered contributions on the plan’s financial statements. To provide some background regarding this debate, one must understand four basic facts:

  1. Participant and Employer contributions to retirement plans are recorded as contribution revenue.
  2. Plan contributions are subject to discrimination testing and legislative limits. When contributions exceed the permitted limits, the participants often receive a distribution of the excess amounts that had been recorded as contributions.
  3. The Form 5500, Schedule H provides line item 2f for employers to report Corrective Distributions of “any elective deferrals and employee contributions distributed or returned to employees during the plan year, as well as any attributable income that was also distributed.”
  4. The AICPA’s Financial Reporting Executive Committee (FinREC) believes that excess contributions should not be considered contributions on the plan books, since they were ineligible contributions for the plan year. To accomplish that, they advocate for a reduction of the contribution revenue for the amount of the excess contribution plus earnings, rather than recording a corrective distribution expense.

Items 3 & 4 lead to the original question: If a contribution is deposited to a retirement plan trust account, but is later treated as an excess contribution to be returned to a participant, is it still a contribution or did it never happen in the first place? It depends on each party’s perspective.

Form 5500 Reporting: The IRS and DOL Perspective

The instructions to the Form 5500 clearly indicate the Internal Revenue Service and Department of Labor’s position that these dollars constitute contribution income when deposited and a corrective distribution when returned to the participant. On a tax basis, the contributions reported on the 5500 would agree with the plan sponsor’s tax deductions and the corrective distributions would be reflected on a Form 1099-R issued to the participant who received the excess funds back and must pay taxes individually.

Financial Statement Reporting: The FinREC Perspective

FinREC recommends that the ineligible contributions be reported as a payable on the plan financials and an offsetting reduction in the contribution revenue amount originally recorded when the excess contribution was made. FinREC recommendations are helpful in clarifying accounting practices, but the Committee’s recommendations are not authoritative generally accepted accounting principles (U.S. GAAP). Per the EBP Accounting and Auditing Guide, the reasoning behind the Committee’s stance of reducing contributions is that the contributions were ineligible for the plan year. However, there is much diversity in practice.

Financial Statement Reporting: Another Perspective

Another approach is to report the excess amount as a distribution. In this case, the plan’s financial statements will also include a liability with the description “Excess Contributions Payable”, since a liability must be reflected in the plan year in which the excess contributions were made.

The Practical Answer to Differences in Reporting

In most cases, the amount of excess contributions reported is not material to the financial statements. Regardless of which method is used, financial statement auditors should disclose the accounting policy used for corrective distributions, as well as any differences between the reporting on Form 5500 and the financial statements.

In the end, we will let the philosophers debate whether falling trees make a sound if you don’t see them fall, and whether ineligible contributions are still contributions. Smart people have fundamental disagreements on many small topics like economics, politics, and religion, to very important ones like the proper accounting for the distribution of excess contributions. As long as there’s adequate documentation of the accounting policy that was used for the financial statements and a reconciliation of any differences with the 5500, all approaches can be correct. Which side of the debate are you on?

Photo by Vincent Brassinne (License)