In order to be considered a qualified plan, a plan must satisfy section 401(a)(17). Section 401(a)(17) provides an annual compensation limit for each employee under a qualified plan.
The 2015 annual limit on compensation for qualified plans is $265,000. By placing a “ceiling” on compensation, the amount of tax deductions for Employers is restricted. In addition, qualified plans such as 401(k) plans are intended to be fair for all participants, regardless of income. As a result, the IRS limits the amount of compensation that may be taken into account for contribution purposes. Let’s suppose your employer matches 100% of deferrals up to 3% of compensation, your compensation is $400,000 and you are deferring 3%. This scenario would generate a matching contribution of $12,000. However, because the 2015 compensation limit is $265,000, your maximum matching contribution would be $7,950.
If contributions are made in excess of the compensation limit, corrective action is required. As a result, it is imperative that your payroll provider limit employees’ compensation for contribution purposes to the IRS Annual Limit.