An employer that recovers surplus assets from a terminated qualified retirement plan owes a federal excise tax under IRC Section 4980 on the full amount of the reversion. The rate is 20%, but it jumps to 50% automatically unless the employer either sets up a qualified replacement plan or grants pro rata benefit increases to participants. The reversion is also included in the employer’s gross income, so regular corporate income tax stacks on top of the excise tax.
When the Tax Applies
A reversion happens when a terminated retirement plan still holds assets after every obligation to participants and beneficiaries has been paid. In practice this is almost always a defined benefit pension plan. Defined contribution plans like 401(k)s don’t pool surplus that can revert, because each participant’s account already belongs to that participant.
Before anything reaches the employer, the plan has to pay all accrued benefits as of the termination date, typically by buying annuities or making lump-sum distributions. Whatever is left after liabilities are settled is the employer reversion, and the excise tax applies to the full amount the employer actually receives. A final actuarial valuation submitted during termination confirms the number.
The 20% Rate and the 50% Default
Section 4980(a) sets the excise tax at 20% of the reversion. Section 4980(d)(1) then raises it to 50% unless the employer takes one of two affirmative steps described below. Because the increase kicks in automatically, an employer that simply pockets the surplus pays 50%. The employer receiving the reversion pays the tax, and the excise tax itself is not deductible against federal income tax.
The dollars are large. On a $10 million reversion, the excise tax alone is $5 million at the default rate and $2 million at the reduced rate. That $3 million gap is the lever Congress built in to push surplus back toward employees.
Two Ways to Keep the Rate at 20%
Qualified Replacement Plan
The employer can establish or maintain a qualified replacement plan that receives a direct transfer from the terminated plan. The replacement plan must cover at least 95% of the active participants in the terminated plan who remain employed after termination. The transfer must equal at least 25% of the maximum reversion the employer could have received, reduced by any benefit increases adopted in the 60 days before termination.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
The replacement plan can be defined benefit or defined contribution. If it’s defined contribution, the transferred assets must be allocated to participants’ accounts in the year of the transfer or credited to a suspense account and allocated ratably over no more than seven plan years.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
The amount moved into the replacement plan is not included in the employer’s gross income, no deduction is allowed for the transfer, and it isn’t treated as a reversion, so no excise tax applies to those dollars either.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer That combination is why the replacement plan is the most tax-efficient path.
Pro Rata Benefit Increases
Instead of a replacement plan, the employer can amend the terminated plan to give pro rata increases in accrued benefits to all qualified participants. The aggregate present value of those increases has to be at least 20% of the maximum reversion the employer could have received. The amendment must be adopted in connection with the termination and take effect immediately on the termination date.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
The 20% benefit-increase threshold is lower than the 25% replacement-plan transfer, but the increase directly reduces the surplus available for reversion by enriching what participants receive from the terminated plan.
The Income Tax Layer
The reversion is included in the employer’s gross income under IRC Section 61 and is subject to regular corporate income tax on top of the excise tax. At the 21% corporate rate, an employer at the 50% excise level can lose over 60 cents of every dollar to combined federal taxes. Even at 20%, the combined bite exceeds 35%. Amounts transferred to a qualified replacement plan escape both taxes.2Internal Revenue Service. Revenue Ruling 2003-85
Who Is Outside the Tax
Section 4980 defines “qualified plan” in a way that carves out two categories of employer:
- Plans maintained by state or local governments, as defined in IRC Section 414(d), are outside the definition. No excise tax applies to a reversion from a governmental plan.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
- Employers that have been exempt from income tax under Subtitle A for the entire period the plan was maintained are also outside the definition, and no excise tax applies.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
An employer in Chapter 7 liquidation (or a similar state-law proceeding) as of the plan termination date is exempt from the increase to 50%. The base 20% rate applies with no need to set up a replacement plan or grant benefit increases.1Office of the Law Revision Counsel. 26 U.S. Code 4980 – Tax on Reversion of Qualified Plan Assets to Employer
A separate provision, IRC Section 420, lets an employer with an overfunded defined benefit plan make a qualified transfer of excess pension assets to a retiree health benefit account or retiree life insurance account without triggering Section 4980. That option is available for transfers through December 31, 2032, and the transferred funds must be used exclusively for retiree health or life insurance costs, subject to specific funding and maintenance-of-effort requirements.
Filing and Paying the Tax
An employer that receives a reversion reports the excise tax on IRS Form 5330.3eCFR. 26 CFR 54.6011-1T – General Requirement of Return, Statement, or List The return is due by the last day of the month following the month the reversion occurred.4Internal Revenue Service. Instructions for Form 5330 – Return of Excise Taxes Related to Employee Benefit Plans A reversion in June means Form 5330 and payment are due by July 31. That deadline is tight, and missing it starts the penalty clock immediately.
Late filing and late payment are separate penalties:
- Failure to file: 5% of the unpaid tax for each month or partial month the return is late, capped at 25%.5Office of the Law Revision Counsel. 26 U.S. Code 6651 – Failure to File Tax Return or to Pay Tax
- Failure to pay: 0.5% of the unpaid tax for each month or partial month the payment is late, also capped at 25%.5Office of the Law Revision Counsel. 26 U.S. Code 6651 – Failure to File Tax Return or to Pay Tax
The IRS also charges interest on unpaid excise taxes. The underpayment rate is set quarterly at the federal short-term rate plus three percentage points. For the first quarter of 2026, that rate is 7% for most taxpayers and 9% for large corporate underpayments.6Internal Revenue Service. Interest Rates Remain the Same for the First Quarter of 2026 On a multimillion-dollar liability, a few months of combined penalties and interest add up quickly, which is why nailing down the reversion amount and the applicable rate before filing pays off.