3946 / Is an employee taxed on current contributions to a plan that has lost its tax qualification?

Contributions to a plan that has ceased to be tax qualified are taxed to an employee in the first year in which his or her right to such amounts is no longer subject to a substantial risk of forfeiture.¹ Thus, an employee is taxed on these contributions to the extent that the employee is vested.

If a plan fails to be tax qualified solely because it does not satisfy either the minimum participation rule (in the case of a defined benefit plan, see Q 3716) or the coverage requirements ( Q 3842), then contributions on behalf of non-highly compensated employees will not be includable in their income. Highly compensated employees must include in income their vested accrued benefits (other than their basis in the account).²

1.  IRC §§ 402(b)(1).