Certified Plan Sponsor Professional (CPSP) Practice Exam

How are employer contributions to 401(k) profit-sharing plans treated for tax purposes?

1. They are subject to FICA and FUTA taxes.

2. They are exempt from FICA and FUTA taxes.

3. They are taxed at a higher rate than employee contributions.

4. They are not subject to any tax regulations.

The correct answer is: They are exempt from FICA and FUTA taxes.

Employer contributions to 401(k) profit-sharing plans are exempt from FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) taxes. This means that when an employer makes contributions to an employee's 401(k) plan, these amounts do not incur payroll taxes, enhancing the benefit for both the employer and the employee. The rationale behind this exemption is to incentivize employer-sponsored retirement plans. By not subjecting these contributions to FICA and FUTA taxes, the government supports the growth of retirement savings among employees, as employers are encouraged to contribute to the retirement plans provided to their workers, without penal aspects of taxation. In contrast, employee contributions to a 401(k) plan are typically made from pre-tax income and are subject to federal and state income taxes at the time of distribution, but they too are not subject to FICA and FUTA taxes when contributed. This tax treatment is a significant advantage for retirement savings, allowing funds to grow tax-deferred until withdrawal at retirement age.