What Is a 404(a)? Deduction Limits for DC, DB, and SEP Plans

Under Section 404(a) of the Internal Revenue Code, an employer that funds a qualified retirement plan can deduct those contributions only within set limits: for a 401(k), profit-sharing, or other defined contribution plan, no more than 25% of the total compensation paid during the year to employees who participate in the plan. Defined benefit pensions use an actuarial calculation instead, and employers sponsoring both types of plan face a combined cap. Contribute more than the law allows, and the excess is nondeductible and carries a 10% excise tax.

The rules below walk through each limit, the compensation figures that drive them, the deposit deadline that controls which tax year the deduction lands in, and what happens when a contribution runs over.

What Section 404(a) Covers

Retirement plan contributions don’t ride on the ordinary business expense rules. Section 404(a) is a separate, more restrictive path, and if a contribution could otherwise be deducted as an ordinary and necessary expense, it’s still allowed only under 404(a) and only up to the ceilings 404(a) imposes.¹ The contribution also has to represent reasonable compensation for services the employee actually performed.

The money has to go into a qualified trust or annuity meeting the requirements of Section 401(a), which means plan assets are held exclusively for participants and their beneficiaries and can’t be diverted elsewhere until all plan liabilities are satisfied.² Nonqualified deferred compensation plans run on different timing rules entirely, with the deduction generally delayed until the year the employee includes the amount in gross income.³

The 25% Cap for Defined Contribution Plans

For profit-sharing plans, 401(k) plans, and money purchase pension plans, employer contributions are deductible up to 25% of the total compensation paid or accrued during the year to all participating employees.¹ Both non-elective contributions (like a profit-sharing allocation) and matching contributions count against that ceiling.

Employee elective deferrals, the salary reductions that go into a 401(k), don’t count against the 25% limit.⁴ They do, however, get counted inside the compensation base used to figure the 25%. So if a company pays $1 million in total compensation to plan participants, the employer can deduct up to $250,000 in employer contributions no matter how much the employees defer out of their own paychecks.

Separately, each participant’s annual additions, combining employer contributions, employee deferrals, and forfeitures, can’t exceed $72,000 in 2026 under the Section 415(c) per-person limit.⁵ Section 415(c) caps what any one account can receive. Section 404(a) caps what the employer can deduct across all participants combined.

Defined Benefit Plan Deductions

Defined benefit plans don’t use a flat percentage. The deductible amount depends on actuarial math, and the employer needs an actuary to produce both the minimum required contribution (the floor) and the maximum deductible contribution (the ceiling).⁴

For single-employer defined benefit plans, Section 404(o) governs the maximum. Added by the Pension Protection Act of 2006, it sets the deductible limit for any taxable year as the greater of a calculated ceiling or the minimum required contribution under Section 430.¹ The calculated ceiling is the sum of the plan’s funding target, its target normal cost, and a cushion amount, minus the current value of plan assets. The cushion equals 50% of the funding target plus projected increases in benefits tied to expected future compensation growth.

The practical takeaway: the employer can always deduct at least the minimum required contribution, even in a year when the formula above would produce a smaller figure. Meeting the plan’s legal funding obligation never costs the deduction.

If You Sponsor Both a DC and a DB Plan

When one employer sponsors both a defined contribution plan and a defined benefit plan and the plans have overlapping participants, Section 404(a)(7) imposes a combined cap. The total deduction across both plans can’t exceed the greater of:

25% of total compensation paid or accrued during the year to beneficiaries under both plans, or
The contributions needed to satisfy the minimum funding requirement for the defined benefit plan under Section 430 (or, if larger, the excess of the funding target over plan assets).

The combined limit will never force an employer to underfund the pension. If the required defined benefit contribution alone is more than 25% of compensation, the employer can still deduct the full required amount. In practice the 25% combined cap bites on the defined contribution side.⁶

The Per-Employee Compensation Cap

Every 404(a) calculation starts with participant compensation, and that compensation is capped per person. For 2026, no more than $360,000 of any single employee’s pay can be taken into account.⁵ If an executive earns $500,000, only $360,000 of that pay feeds into the 25% calculation for that person’s share. The plan document specifies which definition of compensation applies, and the employer has to use it consistently.

SEP and SIMPLE Plans

A Simplified Employee Pension is treated as a profit-sharing plan for deduction purposes, so the same 25%-of-compensation cap applies. For 2026, employer contributions to a participant’s SEP-IRA can’t exceed the lesser of 25% of compensation or $72,000.⁷ SEPs don’t allow elective salary deferrals, with a narrow carve-out for grandfathered SARSEPs established before 1997.

SIMPLE plan employer contributions are deductible in the taxable year that ends with or within the calendar year the contributions were made for. Contributions made after year-end still qualify as long as they’re deposited by the employer’s tax return deadline including extensions.¹ The 2026 SIMPLE employee deferral limit is $16,500, with a $4,000 catch-up at age 50 and a $5,250 catch-up for ages 60 through 63.⁵

Self-Employed Owners

Sole proprietors and partners contributing to their own plans use the same 25% rule, but “compensation” for a self-employed person means net earnings from self-employment reduced by two things: the deductible portion of self-employment tax and the retirement plan contribution itself.⁸

That makes the math circular, because the deduction depends on compensation and compensation depends on the deduction. The IRS supplies a reduced contribution rate to break the loop: divide the plan contribution rate by one plus itself. A 25% plan rate converts to an effective 20% (0.25 ÷ 1.25) applied against net self-employment earnings after subtracting half the self-employment tax.

The deduction lands on Schedule 1 of Form 1040, not Schedule C. It reduces adjusted gross income but doesn’t reduce self-employment tax.⁸

When the Contribution Has to Be Made

The deduction belongs to the taxable year the employer actually pays the contribution into the plan trust. You can’t accrue a deduction for a contribution you plan to make later. The money has to move.

Section 404(a)(6) carves out one important exception. A contribution is treated as made on the last day of the prior taxable year if it’s made on account of that year and deposited no later than the due date of the employer’s tax return, including extensions.¹ It applies to both cash-basis and accrual-basis taxpayers, and it lets an employer close the books, see final income, then size the contribution before filing. Most year-end retirement plan planning runs on this rule.

What Happens If You Exceed the Limit

A contribution above the 404(a) limit is nondeductible, and the excess triggers a 10% excise tax under Section 4972, payable by the employer.⁹ The tax applies to the nondeductible amount as of the close of the employer’s taxable year, and it recurs every year the excess stays in the plan. Employers report and pay the tax on Form 5330, due the last day of the seventh month after the end of the tax year.¹⁰

The excess itself isn’t lost. Section 404(a) permits a carryover to future taxable years.⁴ The carried amount stacks on top of the next year’s contribution, but the combined deduction still can’t exceed that year’s limit. For a defined contribution plan, that means 25% of the following year’s participant compensation. As the carryover gets absorbed, the balance exposed to the 10% tax shrinks.

Several exceptions keep the excise tax from applying in specific situations:

If contributions to a defined contribution plan are nondeductible only because of the Section 404(a)(7) combined limit, matching contributions described in Section 401(m)(4)(A) are excluded from the excise tax calculation.
Contributions to a SIMPLE IRA or SEP that are nondeductible solely because they weren’t made in connection with a trade or business are excluded, though this exception doesn’t cover contributions made on behalf of the employer or the employer’s family members.
An employer can elect to exclude defined benefit plan contributions from the excise tax calculation for a given year, except for multiemployer plan contributions above the full-funding limitation. The election changes the order the Section 404(a)(7) combined limit is applied and disables the other exceptions for that year.
An excess returned to the employer before the Section 404(a)(6) contribution deadline isn’t counted as a nondeductible contribution.

These exceptions sit in Section 4972(c) and require coordination with the plan’s actuary or administrator to apply correctly.⁹

1
Office of the Law Revision Counsel. 26 USC 404 – Deduction for Contributions of an Employer to an Employees Trust or Annuity Plan and Compensation Under a Deferred-Payment Plan
2
Office of the Law Revision Counsel. 26 US Code 401 – Qualified Pension, Profit-Sharing, and Stock Bonus Plans
3
Internal Revenue Service. Publication 5528 – Nonqualified Deferred Compensation Audit Technique Guide
4
Internal Revenue Service. Publication 560 – Retirement Plans for Small Business
5
Internal Revenue Service. Notice 2025-67 – 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Cost of Living
6
Internal Revenue Service. Combined Limits Under IRC Section 404(a)(7)
7
Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs)
8
Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
9
Office of the Law Revision Counsel. 26 US Code 4972 – Tax on Nondeductible Contributions to Qualified Employer Plans
10
Internal Revenue Service. Instructions for Form 5330