Excise Tax on Pension Plan Underfunding: IRC 4971 Tiers and Liens

An employer that underfunds a defined benefit pension plan owes an excise tax under IRC 4971. The excise tax on pension plan underfunding starts at 10% of the shortfall for single-employer plans and 5% for multiemployer plans, and climbs to 100% of the unpaid amount if the shortfall is not corrected in time.¹ The tax is owed to the IRS on top of the money the employer still owes the plan.

What Counts as Underfunding

The trigger depends on the type of plan.

For a single-employer plan, the tax attaches to any unpaid minimum required contribution calculated under Section 430. That contribution is due 8½ months after the end of the plan year, and anything unpaid by that deadline becomes the base for the excise tax.²

Multiemployer plans use a funding standard account that tracks charges and credits across the year. If total charges exceed total credits at year-end, the plan has an accumulated funding deficiency under Section 431, and the tax applies.¹

CSEC plans (cooperative and small employer charity pension plans) also use a funding standard account, and the trigger is a CSEC accumulated funding deficiency at year-end.

How Much the First-Tier Tax Costs

The first-tier rate is a flat percentage of the funding gap, and it applies for every taxable year the shortfall is still open:

Single-employer plans: 10% of the aggregate unpaid minimum required contributions outstanding at the end of any plan year ending within the taxable year.
Multiemployer plans: 5% of the accumulated funding deficiency as of the end of any plan year ending within the taxable year.
CSEC plans: 10% of the CSEC accumulated funding deficiency as of the end of any plan year ending within the taxable year.

Because the percentage restarts each year the deficiency exists, the cost compounds quickly. An employer sitting on a $2 million single-employer shortfall owes $200,000 in excise tax for each year the gap stays open, while still owing the $2 million to the plan.¹

The 100% Second-Tier Tax

If the employer fails to correct the funding gap within the taxable period, the tax jumps to 100% of the unpaid amount.¹ The employer effectively owes the IRS a sum equal to the entire shortfall, in addition to still owing the plan. The taxable period starts at the end of the plan year in which the deficiency exists and ends on the earlier of the date the IRS mails a notice of deficiency for the first-tier tax or the date the IRS assesses that tax.

What Correction Means

For a single-employer plan, correction means contributing enough that, discounted back to the valuation date at the plan’s effective interest rate, the payment equals or exceeds the unpaid minimum required contribution. For multiemployer and CSEC plans, correction means paying enough to zero out the accumulated funding deficiency, including interest at the plan’s valuation rate from the end of the deficiency year through the actual payment date. Partial payments do not satisfy the requirement.

Abatement If You Correct in Time

An employer that does correct during the correction period gets meaningful relief. Under IRC 4961, full correction during the correction period means the second-tier tax is not assessed; if it was already assessed, it is abated; if already collected, it is refunded as an overpayment.³ The correction period runs from the date of the taxable event through 90 days after the IRS mails a notice of deficiency for the second-tier tax, and can be extended if the employer is in Tax Court proceedings or if the IRS finds additional time reasonable and necessary.

Liquidity Shortfall Tax for Single-Employer and CSEC Plans

Single-employer plans and CSEC plans face a separate excise tax when they cannot cover expected benefit payments in the near term. Under IRC 4971(f), if a plan has a liquidity shortfall for any quarter and the employer does not cover it through the required quarterly installment by its due date, the tax is 10% of the uncovered amount.¹

If the shortfall persists for five consecutive quarters, a 100% tax is imposed on the original shortfall amount. Once the 100% tax is paid for a given quarter, no additional liquidity shortfall tax accrues on that same shortfall. The IRS can waive some or all of this tax if the employer shows the shortfall resulted from reasonable cause rather than willful neglect and that reasonable steps were taken to fix it.

Who Actually Owes the Tax

The employer responsible for contributions is the primary taxpayer. If that employer belongs to a controlled group, every member of the group is jointly and severally liable.¹ A controlled group here means any group of businesses treated as a single employer under the IRC’s aggregation rules covering parent-subsidiary chains, brother-sister corporations, and affiliated service groups.

The practical effect is that if a subsidiary plan sponsor cannot pay, the IRS can collect from the parent or any other entity in the group. Plan fiduciaries are not personally liable for the 4971 excise tax. Liability sits with the corporate employer and its controlled group members.

The $1 Million Automatic Lien

A related consequence sits outside the excise tax but often accompanies it. Under IRC 430(k), when unpaid required contributions plus interest exceed $1 million in the aggregate, an automatic lien attaches in favor of the plan against all property of the employer and every other member of the controlled group.² This applies to single-employer defined benefit plans covered by PBGC insurance when the funding target attainment percentage is below 100%. Only the PBGC can perfect and enforce the lien, and the lien amount equals the full unpaid contributions, not just the excess above $1 million.

Funding Waivers

An employer in temporary financial distress can ask the IRS to waive part or all of the minimum funding standard for a plan year under IRC 412(c). The employer must show that meeting the standard would cause temporary substantial business hardship and that enforcement would harm plan participants as a whole.⁴

The IRS looks at whether the employer is operating at a loss, whether there is substantial unemployment in the industry, whether industry profits are declining, and whether the plan is likely to continue only if the waiver is granted. The hardship must be temporary; permanent inability to fund the plan is grounds for denial. A single-employer plan can receive waivers for no more than 3 out of any 15 consecutive plan years. Multiemployer plans get 5 out of 15. A waived amount gets amortized over subsequent plan years and is not treated as a funding deficiency during the waiver period, which shields the employer from the excise tax on that portion.

Reporting and Paying the Tax

The Section 4971 excise tax is reported on IRS Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans). The form requires the employer identification number, the plan number, the shortfall amount, and identification of the liability as first-tier or second-tier.⁵

The filing deadline for Section 4971 taxes is the 15th day of the 10th month after the last day of the plan year, which is October 15 of the following year for a calendar-year plan.⁶ Payment must accompany the form.

For taxable years ending on or after December 31, 2023, employers that file at least 10 returns of any type during the calendar year the Form 5330 is due must file it electronically through the IRS Modernized e-File system. Paper filing when e-filing is required is treated the same as not filing at all.⁷ A hardship waiver from e-filing is available on a year-by-year basis but must be requested affirmatively.

Missing the payment deadline adds a separate penalty of 0.5% of the unpaid tax per month or partial month, capped at 25%. If the IRS issues a notice of intent to levy and the tax still goes unpaid, the monthly rate doubles to 1%. These penalties apply on top of the excise tax and accrue interest.⁸ Reasonable cause can waive the penalty, but the IRS sets a high bar.

1
Office of the Law Revision Counsel. 26 USC 4971 – Taxes on Failure To Meet Minimum Funding Standards
2
Office of the Law Revision Counsel. 26 USC 430 – Minimum Funding Standards for Single-Employer Defined Benefit Pension Plans
3
Office of the Law Revision Counsel. 26 US Code 4961 – Abatement of Second Tier Taxes Where There Is Correction
4
Office of the Law Revision Counsel. 26 USC 412 – Minimum Funding Standards
5
Internal Revenue Service. Form 5330 – Return of Excise Taxes Related to Employee Benefit Plans
6
Internal Revenue Service. Instructions for Form 5330
7
Internal Revenue Service. Mandatory Electronic Filing for Certain Form 5330 Filers Using the IRS Modernized e-File System (MeF)
8
Office of the Law Revision Counsel. 26 US Code 6651 – Failure To File Tax Return or To Pay Tax