IRC Section 404 Deduction Limits: DC, DB, and Self-Employed Rules

Under Internal Revenue Code Section 404, the deduction limits for employer contributions to retirement plans depend entirely on the type of plan. For defined contribution plans like 401(k) and profit-sharing plans, the employer can deduct up to 25% of the total compensation paid to participating employees. For defined benefit pension plans, the deductible amount is set by actuarial funding calculations rather than a flat percentage. For non-qualified deferred compensation, the employer waits to deduct until the employee reports the income. Section 404 overrides the ordinary business-expense rules of Sections 162 and 212, so every dollar an employer contributes to a plan runs through its timing and ceiling.¹

The 25% Limit for Defined Contribution Plans

Section 404(a)(3) caps the employer’s annual deduction for contributions to a profit-sharing plan, 401(k), or other defined contribution plan at 25% of the aggregate compensation paid during the year to employees who participate in the plan.¹

When you build the compensation base, each employee’s pay is counted only up to the Section 401(a)(17) cap, which is $360,000 for 2026. Anything above that for a single employee falls out of the calculation.²

A separate ceiling applies at the participant level. Under Section 415(c), no individual account can receive more than $72,000 in total annual additions for 2026, or 100% of the participant’s compensation if less. Annual additions include employer matching contributions, profit-sharing contributions, and employee elective deferrals. Catch-up contributions for participants age 50 and older sit outside this ceiling.²

Contributions above the 25% deduction limit are not forfeited. The excess carries forward to future years, where the employer can deduct it subject to that year’s 25% cap.¹

Elective Deferrals Sit Outside the 25% Ceiling

This is where the deduction math trips people up. Employee elective deferrals to a 401(k) plan (up to $24,500 for 2026, or $35,750 with the standard age-50 catch-up) do not count against the 25% ceiling. Section 404(n) excludes elective deferrals from the limit and also excludes them when measuring other contributions against the limit.³²

The practical effect: an employer can deduct the full amount of employee salary deferrals on top of up to 25% of aggregate participant compensation in matching and profit-sharing dollars. SECURE 2.0 added a higher catch-up for participants aged 60 through 63, set at $11,250 for 2026, and those enhanced catch-ups are elective deferrals too, so they follow the same rule.

The Combined Limit When You Sponsor Both Plan Types

Employers running both a defined benefit plan and a defined contribution plan hit an additional ceiling under Section 404(a)(7). The combined deduction across both plans cannot exceed the greater of 25% of participant compensation or the minimum required contribution to the defined benefit plan. Amounts above the combined limit carry forward.¹⁴

There’s an escape valve. If the only contributions to the defined contribution plan are elective deferrals, Section 404(a)(7)(C)(ii) turns the combined ceiling off. That matters when an employer wants to fund a defined benefit plan aggressively without the 401(k) creating a combined-limit problem.¹

Defined Benefit Deduction Limits

Defined benefit deductions are actuarial, not percentage-based. Section 404(a)(1) ties the deductible amount to the plan’s funding obligations under Section 430.¹ The minimum required contribution sets the floor, and the maximum deductible amount generally funds the plan up to its full funding target plus a permissible cushion.

Section 415(b) caps the maximum annual benefit any single participant can receive at $290,000 for 2026, adjusted for early retirement and other factors.² Because contributions cannot be earmarked to fund benefits above that cap, the benefit ceiling indirectly constrains what the employer can deduct. An enrolled actuary certifies the plan’s minimum required contribution and funding status annually on Schedule SB of Form 5500, using assumptions that must be reasonable.

Excise Taxes for Missing the Limits in Either Direction

Getting the number wrong at either end triggers penalty taxes.

Underfunding a defined benefit plan brings a Section 4971 excise tax of 10% of the unpaid minimum required contribution for single-employer plans. If the shortfall is not corrected by the end of the taxable period, a second tax of 100% of the remaining deficiency applies.⁵

Overfunding runs into Section 4972, which imposes a 10% excise tax on nondeductible contributions to any qualified plan. Returned excess contributions don’t count if they come back before the tax-return filing deadline, and the employer can elect to exclude certain defined benefit contributions from the nondeductible calculation.⁶

When the Contribution Must Be Made

You don’t have to deposit the money within the tax year to deduct it for that year. Section 404(a)(6) treats a contribution as made on the last day of the preceding taxable year if two things are true: the employer designates it as applying to that prior year for allocation purposes, and the money is actually deposited no later than the due date of the employer’s tax return, including extensions.⁷

For a calendar-year C corporation filing on extension, that generally means October 15 of the following year. Miss the deadline and the deduction shifts into the year the contribution actually lands, which can be an expensive timing error.

Non-Qualified Deferred Compensation Works Differently

Non-qualified deferred compensation plans do not follow the 25% rule at all. Under Section 404(a)(5), the employer’s deduction is allowed only in the taxable year the deferred amount is includible in the employee’s gross income.¹ The employer and employee recognize the same dollar in the same year.

For a typical unfunded NQDC arrangement, the employer waits years. The deduction arrives when the executive actually receives the money and pays tax on it. If the plan covers more than one employee, the employer has to maintain separate accounts for each participant to claim any deduction at all.¹

Trust structure drives timing. In a rabbi trust, the trust assets remain reachable by the employer’s general creditors, so the employee has no unconditional right to the funds, no income is recognized on contribution, and no deduction is available until payment.⁸ A secular trust puts the assets beyond the employer’s creditors, so the employee is taxed immediately on the contribution and the employer gets a current-year deduction, at the cost of the employee losing deferral.

How Self-Employed Owners Calculate the Deduction

A self-employed person contributing to a SEP-IRA or solo 401(k) is subject to the same Section 404 limits, but the calculation is circular because the owner is both employer and employee. Section 404(a)(8) requires substituting “earned income” for “compensation” in the 25% limit.⁹

Earned income is net self-employment earnings reduced by the deductible portion of self-employment tax and by the retirement plan contribution itself. Because the contribution reduces the base used to compute the contribution, the IRS provides a shortcut: divide the plan contribution rate by one plus the rate. At a 25% plan rate, the effective rate for a self-employed person works out to 20% of net self-employment earnings after the SE tax deduction.¹⁰

The Section 404(n) exclusion for elective deferrals applies here too. A sole proprietor with a solo 401(k) can defer up to $24,500 for 2026, plus catch-up amounts if eligible, and those deferrals don’t count against the 25% employer contribution limit. In fact, the elective deferrals are added back to earned income when computing the 25% ceiling for employer contributions.⁹ Self-employed retirement plan deductions go on Schedule 1 of Form 1040, not on Schedule C.¹⁰

SECURE 2.0 Credit Reduces the Deduction

The SECURE 2.0 Act created a tax credit under Section 45E(f) for small employers that make matching or non-elective contributions. If the employer claims the credit, it cannot also deduct the same dollars. The deduction is reduced by the amount of the credit to prevent a double benefit. The Section 404(a)(6) timing rule still applies, so a contribution deposited before the tax-return deadline is treated as prior-year for both the credit and the deduction.¹¹

One Boundary Worth Naming

Employee welfare benefit funds (trusts that pay post-retirement medical, life insurance, severance, or similar benefits) are not governed by the retirement-plan deduction rules above. Section 404(b) pulls them into Section 404’s timing framework, but the actual limits come from Sections 419 and 419A, which tie the deduction to the fund’s qualified cost and cap the reserves it can build.¹² If your question is about funding retiree health coverage or a VEBA rather than a pension or 401(k), that’s a separate regime with its own math.

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
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
3
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
4
Internal Revenue Service. Combined Limits Under IRC Section 404(a)(7)
5
Office of the Law Revision Counsel. 26 USC 4971 – Taxes on Failure to Meet Minimum Funding Standards
6
Office of the Law Revision Counsel. 26 USC 4972 – Tax on Nondeductible Contributions to Qualified Employer Plans
7
Internal Revenue Service. Deductibility of Employer Contributions to a 401(k) Plan Made After the End of the Tax Year
8
Internal Revenue Service. Nonqualified Deferred Compensation Audit Technique Guide
9
Internal Revenue Service. Calculation of Plan Compensation for Sole Proprietorships
10
Internal Revenue Service. Self-Employed Individuals – Calculating Your Own Retirement Plan Contribution and Deduction
11
Internal Revenue Service. Miscellaneous Changes Under the SECURE 2.0 Act of 2022
12
Office of the Law Revision Counsel. 26 USC 419 – Treatment of Funded Welfare Benefit Plans