Late segregation of employee contributions from employer general assets are among the most common—and consequential—compliance issues in retirement plan administration. When contributions such as deferrals or loan repayments aren’t separated from an employer’s general assets as soon as reasonably possible, a prohibited transaction occurs. This not only potentially exposes the employer to excise taxes but also raises fiduciary concerns that can affect multiple parties involved in the plan.
Understanding the mechanics of Form 5330, the rules around prohibited transactions, and the available correction methods is essential for anyone involved in plan operations. Whether you're a plan sponsor, administrator, or service provider, navigating these requirements effectively can help you avoid costly penalties and maintain compliance with fiduciary standards.
Form 5330 is used to report and pay excise taxes under IRC section 4975. When employee contributions to a plan/account covered by IRC § 4975 are not segregated from the employer’s general assets promptly, the delay is a prohibited transaction (note: 403(b) plans are not subject to excise taxes under IRC § 4975). The rationale is simple: the employer benefits from holding plan assets, even temporarily, which violates the fiduciary duty of loyalty to plan participants.
This concept of a “constructive loan” is central to the issue. The employer is seen as borrowing from the plan, gaining liquidity or investment benefit at the expense of participants. That’s why the IRS and DOL take these delays seriously and why any “disqualified person” who “participates” in the transaction may be liable.
The timing of when funds become plan assets is governed by DOL regulations. All employers must segregate employee contributions from their general assets as soon as reasonably possible. For small plans with fewer than 100 participants, separating employee contributions from general assets within seven business days of a pay date is deemed to be reasonable. Larger plans do not have access to this safe harbor definition of reasonable, but all plans, regardless of size, must segregate employee contributions no later than the 15th business day of the following month.
“Reasonable” is a facts-and-circumstances standard. If an employer consistently deposits funds within a certain timeframe, that pattern can establish a baseline; however, deviations from that pattern, especially without documentation, may be deemed unreasonable. For example, if a payroll processor is out sick and deposits are delayed, documenting the situation and the steps taken to mitigate the delay can help demonstrate compliance.
It’s also important to understand that segregation doesn’t necessarily mean depositing funds into the plan trust. What matters is that the employer no longer controls or benefits from the funds. Transferring them to a third-party processor or holding account may suffice, provided the employer relinquishes control.
There are two primary ways to correct late deposits and potentially avoid excise taxes.
First, if the issue is identified and corrected within 14 calendar days of when it should have been noticed, no excise tax is owed. This statutory “correction period” is a narrow window but it offers a straightforward path to resolution.
Second, the DOL’s Voluntary Fiduciary Correction Program (VFCP) provides a structured way to correct late deposits. The VFCP offers two options: self-correction and full application.
Self-correction is available for certain late deposits if the lost earnings are $1,000 or less and the correction is completed within 180 calendar days. The VFCP calculator must be used to determine lost earnings, a form completed on the DOL’s website, and a checklist must be completed and shared with the Plan Administrator. If all conditions are met, the excise tax is waived.
The full application route allows more flexibility, including the use of a later “loss date” to reduce the correction amount. A formal application must be submitted to the EBSA office, and relief from excise taxes can be requested. If granted, the filer receives a letter confirming the waiver.
A common question is whether small amounts owed to former participants must be tracked down. The answer is no. If the amount is under $35 and the participant has no future benefit in the plan, the funds may be retained by the plan. This de minimis rule is codified in the Federal Register.
If the issue cannot be corrected within the statutory period or through VFCP, Form 5330 must be filed. Any disqualified person (or “party-in-interest” in DOL terminology) who participated in the transaction—not just the employer—may be responsible for filing and paying the tax.
The form is due on the last day of the seventh month after the close of the tax year, and a six-month extension is available by filing Form 8868 (note: Form 5558 is no longer used to obtain this extension). If you’re filing for yourself, no power of attorney is needed. If filing on behalf of another party, under current IRS procedures, Form 2848 is required.
Excise taxes come in two tiers. The standard rate is 15% of the amount involved. If the IRS identifies the issue or correction is mishandled, the rate increases to 100%. This “b tax” (in reference to IRC section 4975(b)) is rare but severe, and it underscores the importance of timely and accurate correction.
Another nuance is the concept of “pyramiding.” If a late deposit spans two tax years and isn’t corrected before year-end, a second, separate prohibited transaction occurs beginning on January 1st. This can result in multiple excise taxes arising from the same error.
Excise taxes on late transmittal of employee contributions are assessed on the “amount involved” in the prohibited transaction. This “amount involved” is the theoretical value the employer gains by holding on to the contributions for longer than reasonably necessary. IRS Rev. Rul. 2006-38 states that this theoretical value may be calculated using the interest rate under 6621 that covers the date a prohibited transaction occurs. This means that the amount involved may slightly differ from the amount of lost earnings paid to a plan. Two examples of how to calculate the amount involved, including an example from Rev. Rul. 2006-38, may be accessed here. These examples will also show how the amount involved can differ from the VFCP Calculator output, which is used to calculate the payment owed to the plan under the DOL's correction programs.
ftwilliam.com offers a comprehensive Form 5330 module that makes preparation and filing easier. The software automates calculations for lost earnings and excise taxes, runs edit checks to ensure accuracy, and allows users to upload required attachments. Clients can securely e-sign and submit forms through the portal.
The system is designed to mirror the familiar 5500 filing experience, making it intuitive for users. E-filing is available with the E-Filing Add-On, but paper filing remains an option for the 2024 tax year. As of now, the IRS has not released requirements for 2025 electronic filing, so paper filing may still be necessary for early submissions.
To avoid issues with late deposits, establish a consistent process for transmitting contributions. Document any deviations, especially those caused by illness, system outages, or other disruptions. Act quickly to correct errors and use the VFCP when eligible to avoid excise taxes.
If you must file Form 5330, use ftwilliam.com’s software to ensure accuracy and efficiency. The platform supports individual filings and provides tools to manage attachments, edit checks, and portal access.
Late deposits are more than a timing issue—they’re a fiduciary concern with real financial consequences. By understanding the rules, documenting your processes, and using tools like ftwilliam.com, you can stay compliant, reduce risk, and avoid unnecessary penalties.
Understanding the mechanics of Form 5330, the rules around prohibited transactions, and the available correction methods is essential for anyone involved in plan operations. Whether you're a plan sponsor, administrator, or service provider, navigating these requirements effectively can help you avoid costly penalties and maintain compliance with fiduciary standards.
Why late deposits matter
Form 5330 is used to report and pay excise taxes under IRC section 4975. When employee contributions to a plan/account covered by IRC § 4975 are not segregated from the employer’s general assets promptly, the delay is a prohibited transaction (note: 403(b) plans are not subject to excise taxes under IRC § 4975). The rationale is simple: the employer benefits from holding plan assets, even temporarily, which violates the fiduciary duty of loyalty to plan participants.This concept of a “constructive loan” is central to the issue. The employer is seen as borrowing from the plan, gaining liquidity or investment benefit at the expense of participants. That’s why the IRS and DOL take these delays seriously and why any “disqualified person” who “participates” in the transaction may be liable.
Determining when contributions become plan assets
The timing of when funds become plan assets is governed by DOL regulations. All employers must segregate employee contributions from their general assets as soon as reasonably possible. For small plans with fewer than 100 participants, separating employee contributions from general assets within seven business days of a pay date is deemed to be reasonable. Larger plans do not have access to this safe harbor definition of reasonable, but all plans, regardless of size, must segregate employee contributions no later than the 15th business day of the following month. “Reasonable” is a facts-and-circumstances standard. If an employer consistently deposits funds within a certain timeframe, that pattern can establish a baseline; however, deviations from that pattern, especially without documentation, may be deemed unreasonable. For example, if a payroll processor is out sick and deposits are delayed, documenting the situation and the steps taken to mitigate the delay can help demonstrate compliance.
It’s also important to understand that segregation doesn’t necessarily mean depositing funds into the plan trust. What matters is that the employer no longer controls or benefits from the funds. Transferring them to a third-party processor or holding account may suffice, provided the employer relinquishes control.
Correcting late deposits and avoiding excise taxes
There are two primary ways to correct late deposits and potentially avoid excise taxes. First, if the issue is identified and corrected within 14 calendar days of when it should have been noticed, no excise tax is owed. This statutory “correction period” is a narrow window but it offers a straightforward path to resolution.
Second, the DOL’s Voluntary Fiduciary Correction Program (VFCP) provides a structured way to correct late deposits. The VFCP offers two options: self-correction and full application.
Self-correction is available for certain late deposits if the lost earnings are $1,000 or less and the correction is completed within 180 calendar days. The VFCP calculator must be used to determine lost earnings, a form completed on the DOL’s website, and a checklist must be completed and shared with the Plan Administrator. If all conditions are met, the excise tax is waived.
The full application route allows more flexibility, including the use of a later “loss date” to reduce the correction amount. A formal application must be submitted to the EBSA office, and relief from excise taxes can be requested. If granted, the filer receives a letter confirming the waiver.
A common question is whether small amounts owed to former participants must be tracked down. The answer is no. If the amount is under $35 and the participant has no future benefit in the plan, the funds may be retained by the plan. This de minimis rule is codified in the Federal Register.
When filing Form 5330 is required
If the issue cannot be corrected within the statutory period or through VFCP, Form 5330 must be filed. Any disqualified person (or “party-in-interest” in DOL terminology) who participated in the transaction—not just the employer—may be responsible for filing and paying the tax. The form is due on the last day of the seventh month after the close of the tax year, and a six-month extension is available by filing Form 8868 (note: Form 5558 is no longer used to obtain this extension). If you’re filing for yourself, no power of attorney is needed. If filing on behalf of another party, under current IRS procedures, Form 2848 is required.
Excise taxes come in two tiers. The standard rate is 15% of the amount involved. If the IRS identifies the issue or correction is mishandled, the rate increases to 100%. This “b tax” (in reference to IRC section 4975(b)) is rare but severe, and it underscores the importance of timely and accurate correction.
Another nuance is the concept of “pyramiding.” If a late deposit spans two tax years and isn’t corrected before year-end, a second, separate prohibited transaction occurs beginning on January 1st. This can result in multiple excise taxes arising from the same error.
Calculating owed excise taxes
Excise taxes on late transmittal of employee contributions are assessed on the “amount involved” in the prohibited transaction. This “amount involved” is the theoretical value the employer gains by holding on to the contributions for longer than reasonably necessary. IRS Rev. Rul. 2006-38 states that this theoretical value may be calculated using the interest rate under 6621 that covers the date a prohibited transaction occurs. This means that the amount involved may slightly differ from the amount of lost earnings paid to a plan. Two examples of how to calculate the amount involved, including an example from Rev. Rul. 2006-38, may be accessed here. These examples will also show how the amount involved can differ from the VFCP Calculator output, which is used to calculate the payment owed to the plan under the DOL's correction programs.
How ftwilliam.com simplifies the process
ftwilliam.com offers a comprehensive Form 5330 module that makes preparation and filing easier. The software automates calculations for lost earnings and excise taxes, runs edit checks to ensure accuracy, and allows users to upload required attachments. Clients can securely e-sign and submit forms through the portal. The system is designed to mirror the familiar 5500 filing experience, making it intuitive for users. E-filing is available with the E-Filing Add-On, but paper filing remains an option for the 2024 tax year. As of now, the IRS has not released requirements for 2025 electronic filing, so paper filing may still be necessary for early submissions.
Best practices for compliance
To avoid issues with late deposits, establish a consistent process for transmitting contributions. Document any deviations, especially those caused by illness, system outages, or other disruptions. Act quickly to correct errors and use the VFCP when eligible to avoid excise taxes. If you must file Form 5330, use ftwilliam.com’s software to ensure accuracy and efficiency. The platform supports individual filings and provides tools to manage attachments, edit checks, and portal access.
